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THE 

ARTHUR  YOUNG 

ACCOUNTING 

COLLECTION 


Graduate  School  of 
Business  Administration 

Library  of  the 

University  of  California 

Los  Angeles 


This  book  is  DUE  on  the  last  date  stamped  below 


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Digitized  by  the  Internet  Archive 

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http://www.archive.org/details/appliedtheoryofaOOesquiala 


THE  APPLIED  THEORY 

OF 

ACCOUNTS 


BY" 

PAUL-JOSEPH    ESQUERRE,   C.P.A. 


(FIFTH   PRINTING) 


NEW  YORK 

THE    RONALD    PRESS    COMPANY 

1917 


79505 


Copyright,   1914, 

BY 

The  Ronald  Press  Company 


William  O.  Hewitt  Press,  Broolilyn,  Prioten 
J.  F,  Tapley  Co.,  New  Tork,  Binder* 


Bus.  Adnuib 
library 

HF 

5625 

E77a 


PREFACE 

Just  before  the  dawn  of  the  French  Revolution,  there 
•  was,  at  the  Military  College  of  Brienne,  a  young  student 
whom  his  classmates  called  the  "Visionary."  Never  mix- 
ing in  their  noisy  pastimes,  he  would  spend  hour  after 
hour  in  his  room,  drilling  tin  soldiers  on  a  large  table. 
Dirt,  sand,  and  pieces  of  glass  became  hills,  fields,  and 
rivers;  twigs  picked  up  in  the  playground  were  his  cannon, 
while  leaves,  planted  straight  in  the  sand,  were  to  him  as 
ol  forests.  His  tin  soldiers  were  led  or  blue;  some  were 
^  mounted,  and  others,  on  foot.  Night  after  night,  while 
his  comrades  slept,  the  "Visionary"  would  pitch  the  blue 
soldiers  against  the  red;  the  cannon  would  roar,  and  in- 
fantry and  cavalry,  pushed  by  his  thin  fingers,  would  fall 
dead  on  the  battle-field. 

A  few  years  later,  when  the  English  fleet  blockaded  the 
port  of  Toulon,  and  threatened  the  existence  of  the  Revo- 
lutionary Government,  the  visionary  youth,  now  an  ofificer 
in  the  army  of  France,  pitched  his  "theoretical"  knowl- 
edge against  the  "practical"  knowledge  of  men  who  had 
grown  gray  under  the  soldier's  uniform,  and  to  their 
astonishment,  and  to  the  dismay  of  the  invader,  he  dis- 
covered the  one  strategic  point  which  rendered  a  battery 
of  artillery  so  effective  as  to  compel  the  immediate  retire- 
ment of  the  enemy's  fleet. 

The  young  officer  of  artillery  knew  nothing  of  war- 
fare but  its  theory;  yet  he  succeeded  where  practical 
strategists  had  stood  in  impotent  rage.  Later,  when  he 
became  Emperor  of  the  French,  it  was  said  of  him  that  his 


iv  PREFACE 

.unequalled  knowledge  of  the  theory  of  artillery  opera- 
tions won  his  battles  before  they  were  fought. 

It  is  the  purpose  of  this  book  to  instruct  the  student 
in  the  principles  of  accounting,  as  the  practice  drills  with 
his  tin  soldiers  instructed  Napoleon  the  First  in  the  prin- 
ciples of  war.  May  the  conscientious  presentation  of  these 
principles  of  accounts  teach  the  young  accountant  how  to 
win  the  bloodless  battles  of  his  chosen  profession. 

Accounting  is  essentially  a  militant  science;  if  it  re- 
mains passive,  it  must  die.  To  Hve,  it  must  war  inces- 
santly against  carelessness,  ignorance,  inefficiency,  evil- 
disposed  cleverness,  and,  possibly,  against  dishonesty. 
Having  won,  it  must  rebuild  where  it  has  destroyed;  but 
the  new  structure  must  be  such  that  it  can  never  again  be 
successfully  assailed. 

The  accountant  is  a  judge  to  whom  appeals  are  made 
by  the  employer  against  the  employee;  by  the  "cestui  que 
trust"  against  the  trustee;  by  the  stockholder  against  the 
director;  by  the  director  against  his  associates  or  against 
the  corporate  ofBcers  or  agents;  by  the  government 
against  violators  of  fiscal  laws;  by  the  trader,  the  manu- 
facturer, and  the  financier,  against  the  conclusions  to  be 
drawn  from  their  own  accounts. 

He  is  also  an  adviser  who  must  derive  from  the 
arithmetical  results  of  books  of  account,  often  purposely 
confused,  facts  which  will  enable  him  to  pass  judgment 
upon  financial  conditions,  to  guide  the  judgment  of 
others,  to  suggest  remedies,  and  to  devise  means  of  safe- 
guarding the  interests  of  all  parties,  whether  clients  or  an- 
tagonists. He  must  be  capable  of  refuting  conclusively 
all  assertions  which  are  mere  speculation  based  on  sup- 
posed or  assumed  facts  which  cannot  stand  the  test  of 
accounting  analysis;  he  must  be  able  to  defend  his  ground 
by  submitting  proofs  so  fundamentally  correct  and  so 
conclusive  that  they  cannot  be  challenged;  he  must  be  so 


PREFACE  T 

familiar  with  the  anatomy  of  accounts  that  the  mere  men- 
tion of  a  financial  transaction  will  present  to  his  mind  a 
diagram  of  the  position  which  the  facts  to  be  recorded 
will  occupy  in  the  books,  and  of  the  effect  which  they 
will  have  upon  facts  previously  recorded;  he  must  be 
able  to  perceive  at  once  the  accounting  principle  in- 
volved, and  so  to  apply  it  as  to  compel  figures  to  reveal 
that  which  they  are  prone  to  conceal  from  the  uninitiated. 

If  it  is  true  that  no  one  can  be  a  great  detective  who 
does  not  know  the  psychology  of  the  human  heart,  and 
that  a  recruit  cannot  become  an  efficient  gunner  until  he 
has  been  taught  the  theory  of  ballistic  curves,  it  must  be 
true  that  no  one  can  become  an  accountant  until  he  has 
learned  the  theory  of  accounts.  If  one  is  not  so  equipped, 
he  may  indeed  make  his  way  towards  practical  account- 
ing truth  by  luck,  by  intuition,  or  by  plucky  determina- 
tion, but,  before  he  has  reached  this  goal,  he  has  con- 
sumed his  energy,  exhausted  the  patience  of  his  clients, 
and  too  often  failed  to  furnish  valuable  information  at  the 
opportune  moment. 

The  theory  of  accounts  has  been  evolved  from  the 
study  of  economic  and  financial  conditions,  from  the  de- 
velopment of  commercial  methods,  from  careful  analysis 
of  the  results  attained  in  industries  old  and  new,  from  the 
application  of  the  principles  expressed  by  judicial  de- 
cisions in  litigation  brought  about  through  business  rela- 
tions, from  the  doctrines  of  the  law  merchant,  of  the 
common  law,  and  of  modern  statutes.  It  is  the  out- 
growth of  centuries;  and  while  its  principles  are  immut- 
able, they  are,  at  the  same  time,  susceptible  of  different 
methods  of  application,  which  though  apparently  irrecon- 
cilable among  themselves,  are  worthy  of  consideration  on 
their  individual  merits. 

-When  about  to  pass  judgment  upon  the  actions  of 
individuals  or  of  nations,  we  are  careful  to  inquire  into 


VI 


PREFACE 


the  motives  which  actuated  them;  and  although  we  may 
not  be  in  sympathy  with  the  methods  employed,  we  do 
not  condemn  them  provided  they  were  adequate  to  the 
purpose  in  hand.  But  when  we  come  to  .accounting,  we 
are  naturally  arbitrary;  the  purpose  is  forgotten,  and  the 
omy  question  at  issue  seems  to  be  the  nature  of  the  means 
employed.  And  yet,  the  question  of  adequacy  is  as  vital 
to  accounting  as  it  is  to  all  the  undertakings  of  man- 
kind. 

The  purpose  of  the  baker  of  the  rural  districts  of 
southern  Europe,  who  in  common  with  the  majority  of 
his  customers  is  barely  able  to  read  and  write,  is  better 
served  by  the  sticks  on  which  he  notches  his  sales,  than 
it  would  be  by  the  most  handsomely  ruled  ledger  and 
cash  book.  Similarly,  as  the  purpose  of  the  small  trader 
of  all  lands  is  to  keep  accounts  with  his  customers  and 
creditors,  he  need  not  trouble  himself  with  what  has  been 
termed  "the  only  scientific  system  of  keeping  accounts" 
(double  entry),  since  single  entry,  much  abused  as  it  may 
be,  is  able  to  tell  him  all  that  he  wishes  to  know,  and  is 
much  better  adapted  to  his  mental  equipment.  If  the 
merchandise  account  of  a  trader  reveals  the  information 
of  which  he  is  in  need,  why  should  he  heed  the  indignant 
protests  of  philosophers  of  accounting  who  tell  him  that 
there  is  really  no  such  thing  as  a  merchandise  account, 
and  that  the  use  of  complex  accounts  will  rob  him  of  the 
fruit  of  his  industry,  by  hiding  from  him  the  business 
truth?  And  if  the  purpose  of  the  modest  manufacturer  of 
a  staple  product,  the  market  price  of  which  is  as  well 
settled  as  the  demand  therefor,  is  to  be  as  fairly  successful 
as  the  conditions  of  his  particular  industry  will  permit, 
why  should  he  be  made  to  sacrifice  a  good  part  of  his 
income,  in  order  that  he  may  know  through  the  use  of 
"production  factors"  or  otherwise,  the  cost  of  every  atom 
of  the  product  which  he  manufactures? 


PREFACE  rii 

It  has  been  asserted  repeatedly  that  it  is  impossible  to 
bring  together  ten  accountants  whose  views  will  har- 
monize on  any  given  topic  of  their  profession.  This  will 
always  be  true  to  a  greater  or  less  extent,  since  the 
human  mind  is  not  adapted  to  the  acceptance  of  a  single 
standard  of  truth.  But  these  divergent  views  will  become 
largely  harmonized  just  as  soon  as  it  is  realized  that  if  a 
student  of  surgery  cannot  be  trusted  with  an  operation 
until  he  has  mastered  the  anatomy  of  the  human  body, 
the  student  of  accounting  cannot  be  trusted  with  the 
finances  of  a  business  until  he  has  mastered  the  theory  of 
accounts. 

Paul- Joseph  Esquerr^. 
New  York  City, 
September  i,  19 14. 


CONTENTS 


PART  I— BUSINESS  ORGANIZATION 

Chapter  I.     The  Copartnership 
Preliminary 
Sole  Proprietorship 
The  Copartnership 
Limited  Partnerships 
Nominal  Partners 
Articles   of   Copartnership 
The  Accountant's  Duty 
The  Partnership  a  Quasi-Legal  Entity 
Acquisition  of  Partnership  Property 
Partners'  Debts 
General  Partnership  Rules 
Precedence  of  Claims  Against  Partnership 
Value  of  the  Good-Will 
Partnership  Paper 
Status  of  Retiring  Partners 
Status  of  Continuing  Partners 
Status  of  Incoming  Partners 

Chapter  II.    The  Corporation — Stock  Securities 

The  Corporation  Defined 

Corporations   Classified 

Shares,  Capital,  and  Capital  Stock 

Dividends 

Kinds  of  Stock  and  Its  Issue 

Stock  Subscriptions 

Property  Acquired  by  Stock  Issue 

Labor  or  Services  as  a  Consideration 

Stock  Issued  as  a  Bonus 

Borrowed  Capital — Corporate  Bonds 

Classification  of  Bonds  as  to  Security 

(1)  Secured  Bonds 

(2)  Partly  Secured  Bonds 

(3)  Unsecured  Bonds 
Typical  Bond  Issues 

ix 


X  CONTENTS 

Chapter  III.    The  Corporation — Organization  and  Management 

Corporate  By-Laws 
The  Board  of  Directors 
Stockholders 
Corporate  Officers 

Chapter  IV.    The  Corporate  Records 

Statutory  Requirements 

(1)  Minute  Book 

(2)  Subscription  Ledger 

(3)  Stock  Certificate  Book 

(4)  Stock  Book  or  Stock  Ledger 

(5)  Corporate  (or  Stock)  Journal 

(6)  Stock  Transfer  Book 

PART  II— THE  GENERAL  THEORY  AND  TECHNIQUE  OF 

ACCOUNTS 

Chapter  V.    Accounting  Systems — Single  Entry 

The  Principles  of  Single  Entry 

Single-Entry  Ledger  Accounts 

Debits  and  Credits 

The  Effect  of  Debits  and  Credits 

Equations  of  Single-Entry  System 

Sources  of  Gains  and  Losses  Not  Shown 

Proprietor's  Account 

Closing  the  Accounts 

Practicability  of  System 

Chapter  VI.     Accounting  Systems — Double  Entry 

The  Purpose  of  Double  Entry 

Principles  of  Double  Entry 

A  Balancing  System 

Rules  for  Journalizing 

Profit  and  Loss  Account  and  Nominal  Accounts 

Rules  for  Double  Entry 

Basic  Differences  Between  Single  and  Double  Entry 

Passing  from  Single  Entry  to  Double  Entry 

Chapter  VII.    Accounting  Systems — Triple  and  Quadruple  Entry 

Logismography 
Statmography 


CONTENTS  xi 

Chapter  VIII.    The  Financial  Books— The  Journals 

The  Journal 

The  Sub-Journals 

Purchasing  Department — Purchase  Journal 

Sales  Department — Sales  Journal 

Treasurer's  Department — Cash  Journal 

Petty  Cash  Book 

Notes  and  Bills  Journal 

Pay-Roll  Journal 

Specially  Ruled  Journals 

Chapter  IX.    The  Financial  Books — The  Ledger  and  Voucher 

Record 

The  Structure  of  the  Ledger 
Variations  of  the  Standard  Ledger 
Private  Ledger 
Voucher  Record 

Chapter  X.     The  Technique  of  Posting 

Functions  of  the  Ledger 
Rules  for  Posting 

Chapter  XI.    Controlling  Accounts 

General  and  Subsidiary  Ledgers 
Genesis  of  the  Controlling  Account 
Theory  of  the  Controlling  Account 
Self-Balancing  Ledger 

Chapter   XII.     Classification   of   Accounts 

General    Classification 

(1)  Real  Accounts 

(2)  Nominal  Accounts 

(3)  Accounts  Partially  Real  and  Partially  Nominal 
Asset  and  Liability  Classification 

Assets  and  Asset  Accounts 
Liabilities  and  Liability  Accounts 

PART  III— THE  THEORY  OF  THE  ASSET  ACCOUNTS 

Chapter  XIII.     Cash  Account— Petty  Cash 

The  Theory  of  the  Cash  Account 

The  Cash  Account  and  the  Cash  Balance 

A  Correct  Cash  Account 


xH  CONTENTS 

Nature  of  Petty  Cash 
Maintaining  the  Imprest  Fund 
Theory  of  the  Imprest  Fund 
Special  Duties  of  the  Petty  Cashier 

Chapter  XIV.    Accounts  with  Customers 

Entries   in   Customers'  Accounts 
Trade  Discounts 
"Accounts  Receivable" 

Chapter  XV.    Notes  and  Bills  Receivable 

Notes  Receivable 

Treatment  of  Notes  Receivable 

Treatment  of  Contingent  Liability  on  Notes  Discounted 

Dishonored  Notes 

Bills  Receivable 

Chapter  XVI.    Accounts  with  Goods 

Merchandise  Account  of  Trading  Concerns 

Analysis  of  the  Merchandise  Account 

Subdivisions  of  the  Merchandise  Account 

Inventory  of  Trading  Merchandise 

Merchandise  Accounts  of  Manufacturing  Concerns 

Inventories     of    the     Merchandise     Accounts     of     Manufacturing 

Concerns 
Inventory  of  Raw  Materials  and  Sundry  Supplies 
Inventory  of  Goods  in  Process 
Inventory  of  Finished  Goods 
Inventory  When  There  Is  No  Cost  System 
Apportionment  of  Overhead  Expenses 

(1)  Labor  Rates 

(2)  Machine  Rates 

The  Problem  of  Expense  Distribution 

Chapter  XVII.     Consignments — Shipments  Inward 

Relations  of  Consignor  and  Consignee 

Consignee's  Duties  and  Liabilities 

The  Factor's  Accounts  and  Accounting 

Books  of  the  Factor 

Books  of  the  Factor — Agency  Accounts  Kept  in  General  Books 

Books  of  the  Factor — Agency  Accounts  Kept  in  Separate  Books 

The  Recording  of  Consignments  Inward — Occasional  Consignee 


CONTENTS  •  xiii 

The  Occasional  Consignee  Theory 
First  Argument  and  Method 
Second  Argument  and  Method 

Chapter  XVIII.    Consignments — Shipments  Outward 

Accounting  Methods 
First  Hypothesis 
Second  Hypothesis 
Third  Hypothesis 

First  Method 

Second  Method 

Chapter  XIX.    Land  and  Buildings 

Distinction   Between  "Land"  and  "Buildings' 

Plant  Land 

Investment  in  Lands 

Buildings 

Capital  Expenditures 

Revenue   Expenditures 

Chapter  XX.     Building  Equipment,  Furniture  and  Fixtures,   De- 
livery Equipment,  Patterns,  Other  Equipment 

Realty  Fixtures  and  Personalty  Fixtures 

The  Law  of  Fixtures 

Distinction  Between  Realty  and  Personalty  Fixtures 

Furniture  and  Fixtures 

Delivery  Equipment 

Patterns 

Other  General  Equipment 

Chapter  XXI.    Machinery  and  Tools 

Classification  of  Machinery  and  Tools 

Machine  and  Tool  Accounting 

Universal  Machines 

Special  Machines  • 

Depreciation 

Shop  and  Hand  Tools 

Chapter    XXII.      Good-Will,    Patents,    Trade-Marks,    Copyrights, 

Franchises 
Good-Will 

Definition 

Personal  Character  of  Good-Will 

The  Good-Will  of  Corporations 


xiv  CONTENTS 

Good-Will  as  an  Asset 
Depreciation  of  Good-Will 
Creation  of  Good-Will 

Patents 

Nature  of  Patents 

Treatment  of  Patents 

Trade-Marks 
Definition 

Copyrights 

Definition 

Copyrights  as  an  Asset 

Franchises 
Definition 

Primary  Franchises 
Secondary    Franchises 
Charges  Against  Franchises 

Chapter  XXIII.    Investments 
Surplus  Capital 
Speculative  Investments 
Permanent  Investments 

(1)  Loans  Secured  by  Bonds  and  Mortgages 

The  Mortgage  Contract 

Mortgage  Interest 

Accounting  Procedure  and  the  Mortgage  Register 

The  Nature  of  Security 

(2)  Loans  Secured  by  Collateral 

(3)  Investments  in  Bonds  of  Other  Companies 

The  Interest  Account 
Relation  of  Cost  to  Income 
Investment  Accounting 

(4)  Investments  in  Stocks  of  Other  Companies 

(5)  Investments  in  Real  Estate 
Accounting  for  Real  Estate  Investments 

Chapter    XXIV.     Specific    Funds,    Reserve    Funds,    and    Funded 

Reserves 
Specific  Funds 
Reserve  Funde 
Funded  Reserves 
Sinking  Funds 


CONTENTS  XV 

Chapter  XXV.    Accrued  Income  Not  Due 

Income  from  Investments 

The  Cash  Basis 

The  Accrual  Basis 

Nature  of  Dividends 

Record  of  Earnings  on  Investments 

Income  from  Bonds 

Chapter  XXVI.    Accounts  Partially  Real  and  Partially  Nominal- 
Deferred  Debit  Items 

Allocation  of  Periodical  Expenses 

Common  Accounts  Partially  Real  and  Partially  Nominal 

Fire  Insurance  Premiums 

Advertising  Contracts 

Stable  Supplies,  Stationery  and  Printing,  Advertising  Matter 

Clearing  Partially  Real  and  Partially  Nominal  Accounts 

First  Method 

Second  Method 
Deferred  Debit  Items 
Organization  Expense 


PART  IV— THE  THEORY  OF  THE  LIABILITY  ACCOUNTS 

Chapter  XXVII.    Capital  Stock 

The  Share  and  Its  Functions 

Capital  Stock  as  a  Liability 

Capital  Stock  Records 

The  Status  of  Unissued  Stock 

Premiums  on  Capital  Stock 

Discount  and  Premium  Accounts 

Treasury  Stock 

Accounting  for  Treasury  Stock 

Donation  Account 

Chapter  XXVIII.    Bonded  Debt 

General  Considerations 

Bond  Issues 

Accounting  Theories  of  Bond  Issues 

Bonds  Acquired  by  Issuing  Company 

Premiums  and  Discounts  on  Bond  Sales 

Premiums  as  Deductions  from  Principal 


xvi  CONTENTS 

Chapter  XXIX.    Secured  Debt— Unsecured  Debt 

Secured  Debt 
Real  Estate  Mortgages 
Chattel  Mortgages 
Interest  on  Mortgaged  Debt 
Secured  Debt 
Warehouse  Receipts 

Unsecured  Debt 

Notes  and  Bills  Payable 
Bills  Payable 
Memorandum  Checks 
Promissory  Notes  Payable 

Chapter  XXX.     Accounts  Payable — Dividends  Payable 
Accounts  Payable  Records 
Dividends  Declared  and  Unpaid 
Profits  Available  for  Dividends 

Dividends  from  Income — from  Increased  Valuations 
Stock  Dividends 
Accounting  Treatment  of  Dividends 

Chapter  XXXI.    Accrued  Liabilities — Deferred  Credit  Items 

Accrued  Liabilities 

Taxes,  Licenses,  Assessments,  and  Fees 

Classification  of  Taxes 

(1)  Business  Taxes 

(2)  Property  Taxes 

(3)  Excise  Taxes 

(4)  Inheritance  Taxes 
Deferred  Credit  Items 

Chapter  XXXII.    Reserves  and  Surplus — Proprietorship  Accounts 

Reserves  and  Surplus 

Distinction  Between  Reserves  and  Surplus 
Classification  of  Reserves 

(1)  Reserves  for  Depreciation 

(2)  Operating  Reserves 

(3)  Reserves  for  Surplus  Contingencies 

(4)  Reserves  for  Redemption  of  Debt 

(5)  Secret  Reserves 

(6)  Reserves  for  Exhaustion  of  Physical  Assets 
Creation  of  Reserves 

Provision  for  Depreciation 
Provision  for  Exhaustion 


CONTENTS  xvU 

Proprietorship  Accounts 

Positive  and  Negative  Components 
Drawing  Accounts 

PART  V—FINANCIAL  STATEMENTS 
Chapter  XXXIII.     Financial  Statements  Based  on  Single  Entry 

The  Statement  of  Assets  and  Liabilities 

The  Statement  of  Resources  and  of  Their  Application 

Proof  of  Ledger  Assets 

Chapter  XXXIV.    Trial  Balance  and  Working  Balance  Sheet 

Trial  Balance 

Classified  Trial  Balance,  or  Working  Balance  Sheet 

Chapter  XXXV.    The  Balance  Sheet 

Arrangement  as  to  Assets  and  Liabilities 

Arrangement  as  to  Order  of  Items 

Variations  in  Arrangement  of  Balance  Sheet 

Double-Form  Balance  Sheet 

Periodical  Fluctuations  in  Double-Form  Balance  Sheet 

Opposition  of  Balance  Sheet  Items 

Form  of  General  Balance  Sheet 

Reading  a  Balance  Sheet 

Chapter  XXXVI.     Special  Forms  of  Balance  Sheets 

Bank  Balance  Sheet 

The  Balance  Sheet  of  Life  Insurance  Companies 

Balance  Sheet  of  Steam  Roads  Engaged  in  Interstate  Commerce 

Chapter  XXXVII.    The  Statement  of  Income  and  Profit  and  Loss 

Elements  of  Statement 

Mechanism  of  Statement 

Comment  on  the  Statement 

Cash  Discounts 

Cost  of  Goods 

Interest  as  an  Element  of  Cost 

Book  Increase  of  Cost 

Statement  in  Account  Form 

Statement  for  Steam  Roads  Engaged  in  Interstate  Traffic 

Statement  of  Cash  Receipts  and  Disbursements 


xviii  CONTENTS 

Chapter  XXXVIII.    The  Consolidated  Balance  Sheet 

"Consolidation"  and  "Consolidated"  Balance  Sheets 
Form  of  Consolidated  Balance  Sheet 
Formation  of  Consolidated  Balance  Sheet 

Chapter  XXXIX.    The  Statement  of  Affairs 

Appointment  of  Receivers 

Status  of  the  Statement  of  Affairs 

Asset  Side  of  Statement 

Liability  Side  of  Statement 

Preparation  of  Statement  of  Affairs 

Preparation  of  Deficiency  Account 

Treatment  of  Reserves 

Arrangement  of  the  Statement  of  Affairs 

Arrangement  of  Deficiency  Account 

Chapter  XL.     Realization  and  Liquidation 

Method  of  Closing 

Statement  of  Realization  and  Liquidation 

Preparation  of  Realization  and  Liquidation  Account 

Principles  Involved 

Peter  Post  Problem 

Chapter  XLI.    The  Accounts  of  Fiduciaries 

Academic  Theories 

Statutory  Provisions 

Executor's  Accounting 

Payment  of  Debts  and  Legacies 

The  Executor's  Compensation 

Form  of  Executor's  Account 

Contents  of  Schedules 

Differentiation  Between  Principal  and  Income 

Practical  Problems 

(Pages  521  to  575) 


The  Applied  Theory  of  Accounts 

Part  I — Business  Organization 


CHAPTER   I 

THE  COPARTNERSHIP 

Preliminary 

The  study  of  the  theory  of  accounts  presupposes  a 
good  working  knowledge  of  the  laws  which  regulate  busi- 
ness— whether  conducted,  by  individuals,  by  associations 
of  interest  known  as  copartnerships,  or  by  artificial  bodies 
created  by  law,  and  known  as  corporations — as  well  as  of 
the  principles  of  corporation  finance.  But  as  it  might  be 
considered  far  too  optimistic  to  assume  that  every  stu- 
dent, or  would-be  student,  of  accounting  is  thus  equipped, 
a  brief  sketch  of  the  legal  characteristics  of  the  several 
types  of  business  organization  is  given  here. 

Sole  Proprietorship 

The  business  rights  and  privileges  of  the  individual 
seeking  wealth  independently,  are  affected  only  by  such 
laws  and  customs  as  regulate  the  ordinary  relations  of 
men  with  their  fellow-men  and  with  governing  bodies. 
Outside  of  such  legal  steps  as  every  sole  proprietor  must 
take  to  register  his  business  and  to  comply  with  local 
police  and  fiscal  regulations,  he  is  at  liberty  to  conduct  his 
enterprise  as  he  pleases,  provided  he  does  not  interfere 
with  the  rights  of  others,  or  with  public  policy.     As  to 

19 


20  BUSINESS    ORGANIZATION 

partnerships  and  corporations,  their  activities,  through 
law  and  time-honored  customs,  have  become  subject  to 
restrictions  which  act  for  the  benefit  and  welfare  of  their 
members,  as  well  as  of  outsiders  who  deal  with  them. 

The  Copartnership 

An  association  of  men  in  partnership  is  thus  defined 
by  Chancellor  Kent:  "A  contract  of  two  or  more  com- 
petent persons  to  place  their  money,  effects,  labor,  and 
skill,  or  some  or  all  of  them,  in  lawful  commerce  and  busi- 
ness, and  to  divide  the  profits  and  bear  the  losses  in 
certain  proportions." 

In  the  Federal  courts  a  copartnership  has  been  spoken 
of  as,  "A  contract  of  mutual  agency,  each  partner  acting  as 
a  principal  in  his  own  behalf,  and  as  an  agent  for  his 
copartners."* 

There  are  two  broad  classes  of  partnerships: 

1.  General  Partnerships 

2.  Limited  Partnerships 

As  accountants  generally  understand  the  term,  a  gen- 
eral partnership  is  one  in  which  all  the  partners  are  ten- 
ants in  common,  every  member  sharing  with  his  asso- 
ciates the  liability  for  such  debts  as  the  firm  has  incurred 
through  the  actions  of  the  individual  partners  as  agents 
of  the  other  members.  The  law  of  New  York  says: 
"Every  general  partner  is  an  agent  of  the  partnership  in 
the  transaction  of  business,  and  has  authority  to  do 
whatever  is  necessary  to  carry  on  the  business  in  the 
ordinary  manner." 

Limited  Partnerships 

As  distinguished  from  general  partnerships,  the 
limited  partnership   is  characterized  by  the  inability  of 

•  Karrick  v.  Haraman,  i68  U.  S.    324,328;  18  C.  St.  135;  42  L.  Ed.  484. 


THE    COPARTNERSHIP  21 

some  of  its  members  to  act  as  agents  for  the  others  or  to 
have  any  voice  whatsoever  in  the  management  of  the  busi- 
ness; and  also  by  the  limitation  of  the  liability  of  such 
members  to  the  amounts  of  the  capital  contributed  by 
them. 

In  some  states,  all  the  members  of  a  limited  partner- 
ship are  liable  only  to  the  extent  of  the  capital  which 
they  have  contributed;  but  in  general,  limited  partner- 
ships must  have  at  least  one  general  partner  who  is  liable 
for  any  deficiency  in  the  assets  available  for  the  liquida- 
tion of  the  partnership  liabilities. 

The  members  of  a  partnership  who  enjoy  the  privi- 
lege of  limited  liability  are  referred  to  as  "special  part- 
ners." A  peculiarity  of  their  status  is  that  they  must 
contribute  capital  to  become  partners,  while  general 
partners  are  not  legally  bound  to  contribute  anything.  In 
many  states,  the  statutes  even  require  special  partners  to 
contribute  "cash,"  or  "lawful  money  of  the  United 
States." 

The  most  important  of  the  restrictions  to  which  spe- 
cial partners  are  subject,  is  that  which  prohibits  them 
from  withdrawing  their  capital  in  the  form  of  dividends, 
profits,  loans,  or  salaries,  etc.  If  they  do  so,  they  forfeit 
the  privilege  of  limitation,  and  become  liable  as  general 
partners.  Further,  when  at  dissolution  of  the  partnership 
the  assets  are  not  sufficient  to  Hquidate  the  liabiHties, 
special  partners  are,  in  some  states,  denied  the  right  of 
sharing  in  the  firm's  assets. 

Limited  partnerships  may  have  members  who  while 
enjoying  limited  liability,  are  permitted  to  have  a  voice 
in  the  management  of  the  concern.  They  are  called  "dor- 
mant partners."  Their  connection  with  the  concern  must 
at  all  times  remain  secret,  or  they  lose  the  privilege  of 
limited  liability. 

An  important  distinction  between  limited  and  general 


22  BUSINESS    ORGANIZATION 

partnership  is,  that  as  soon  as  insolvency  is  ascertained  an 
injunction  may,  upon  the  application  of  a  creditor,  be  ob- 
tained against  a  limited  partnership  and  a  receiver  ap- 
pointed; whereas,  in  general  partnerships  a  creditor  has 
no  such  equitable  remedy  unless  it  is  shown  that  by  allow- 
ing the  firm  to  continue,  his  interest  would  be  grievously 
injured  through  mismanagement.  While  this  remedy  has 
sometimes  been  granted  to  the  creditors  of  a  general  co- 
partnership, it  is  not  generally  thought  to  belong  to  them 
by  right. 

Nominal  Partners 

A  nominal  partner  is  one  who,  while  not  in  fact  a 
partner  of  either  a  general  or  limited  partnership,  holds 
himself  out  to  be  such,  to  the  prejudice  of  an  innocent 
third  party.  If  the  injured  party  seeks  redress,  the  law 
makes  the  nominal  partner  a  general  partner  for  the  pur- 
pose of  the  particular  litigation,  and  attaches  upon  him  a 
general  liability. 

Articles  of  Copartnership 

In  partnerships,  whether  general  or  limited,  the  part- 
ners are  usually  bound  by  a  written  agreement,  known  as 
"Articles  of  Copartnership,"  which  purports  to  regulate 
the  actions  of  the  associates,  to  set  forth  their  duties, 
rights,  and  privileges,  and  to  define  the  scope  of  the  en- 
terprise. And  since  copartnerships  may  be  terminated 
otherwise  than  through  insolvency  and  bankruptcy,  by: 
(i)  the  expiration  of  the  term  for  which  created;  (2) 
mutual  consent;  (3)  the  death  of  one  of  the  partners;  (4) 
the  transfer  by  a  partner  of  his  interest  to  third  persons 
not  partners;  (5)  the  contemplated  admission  of  a  new 
partner  not  satisfactory  to  all  the  others;  and  (6)  the  re- 
tirement of  one  of  the  partners,  it  follows  that  articles  of 
partnership,  in  order  to  be  well  drawn,  should  attempt 


THE    COPARTNERSHIP  23 

to  foresee,  and  to  provide  for,  the  conditions  which  may 
prevail  at  dissolution. 


Th6  Accountant's  Duty 

It  is,  however,  because  articles  of  copartnership  are 
seldom  thorough,  far-seeing,  and  clearly  expressed,  that 
accountants  are  so  often  called  upon  to  minister  to  the 
partnership  about  to  be  dissolved,  and  to  certify  to,  or 
deny,  the  supposed  justice  of  the  claims  made  by  one 
partner  against  the  others.  The  duty  of  the  accountant 
is  to  conform  to  the  spirit  of  the  articles  binding  the 
partners;  or,  if  this  be  impossible,  to  interpret  the  pro- 
visions thereof  in  the  sense  in  which  the  questions  at  issue 
are  generally  understood  by  similar  types  of  business  asso- 
ciation; or  this,  in  turn,  failing,  to  seek  the  assistance  of 
the  law  of  partnership,  of  which  the  salient  points  are 
given  below. 

The  Partnership  a  Quasi-Legal  Entity 

While  it  is  generally  understood  that  partnerships  are 
not  legal  entities,  still  it  seems  to  be  in  line  with  modern 
ideas  to  consider  them  as  such.  Courts  of  law  have  re- 
ferred to  them  as  "The  ideal  being,  known  as  the  partner- 
ship"; the  United  States  Bankruptcy  Act  appears  to  con- 
sider them  as  entities  capable  of  being  thrown  into  bank- 
ruptcy, although  the  individual  partners  may  not  be.  In 
stating  accounts  before  a  master  or  a  referee,  or  in  cases 
of  litigation  between  partners,  it  is  customary  to  open  an 
account  with  the  firm;  this  account  is  debited  with  the 
contributions  of  the  partners  (but  not  with  the  amount 
paid  by  one  partner  to  another  partner  personally,  for  a 
place  in  the  firm)  and  with  all  moneys  advanced  by  the 
partners  to  the  firm  or  spent  by  them  for  the  benefit  of 
the  firm  as  such. 


24 


BUSINESS    ORGANIZATION 


Acquisition  of  Partnership  Property 

Everything  which  the  partners  contribute  in  the  form 
of  capital,  either  at  the  incipiency  of  their  relation  with 
one  another,  or  subsequently,  is  considered  as  property  of 
the  firm  as  a  whole. 

Although  oral  agreements  may  in  some  cases  be 
deemed  vaHd,  it  appears  to  be  the  rule  that  real  property 
owned  by  a  prospective  partner,  becomes  firm  property 
only  by  virtue  of  a  written  contract  transferring  the  in- 
terest in  the  land  estate  from  the  individual  to  the  firm. 
But  when  real  estate  has  been  acquired  with  the  funds 
and  for  the  purposes  of  the  firm,  it  is  the  property  of  the 
firm,  even  though  the  title  is  in  the  name  of  one  of  the 
partners  and  there  is  nothing  but  a  verbal  agreement  to 
the  effect  that  it  was  to  become  the  firm's  property. 

Partners*  Debts 

The  debts  contracted  by  individual  partners,  either  be- 
fore or  during  the  life  of  the  partnership,  may  become 
debts  of  the  firm  by  mutual  consent. 

General  Partnership  Rules 

Unless  specific  provisions  to  the  contrary  are  inserted 
in  the  articles  of  copartnership,  or  some  fact  exists  tend- 
ing to  show  that  the  partners  intended  it  otherwise,  the 
following  rules  prevail: 

I.  All  advances  made  by  individual  partners  to  the 
firm,  and  all  debts  incurred  by  them  for  the  partnership, 
are  loans  to  the  copartnership,  and  make  the  partners  so 
contributing,  creditors  of  the  same.  As  creditors,  they  are 
entitled  to  interest  on  their  advances  and  on  such  sums  as 
they  have  paid  personally  for  the  benefit  of  the  firm  as 
such. 


THE    COPARTNERSHIP 


25 


2.  Interest  is  not  to  be  credited  on  the  amount  of 
capital  invested,  even  though  the  capital  contribution  of 
one  of  the  partners  is  greatly  in  excess  of  that  of  others. 

3.  Interest  is  not  to  be  charged  on  withdrawals.  If, 
however,  the  amounts  withdrawn  by  a  partner  are  in  ex- 
cess of  the  limit  allowed,  fairness  requires  that  he  shall  be 
charged  with  the  interest  which  he  has  caused  the  firm  to 
lose. 

4.  Interest  is  not  to  be  charged  on  moneys  remain- 
ing in  the  possession  of  a  partner  pending  dissolution  and 
winding  up. 

5.  If  no  rate  of  interest  is  mentioned,  the  legal  rate 
prevails  whenever  transactions  occur  raising  the  question 
of  interest. 

6.  Profits  and  losses  are  to  be  shared  equally,  no  mat- 
ter how  unequal  the  capital  accounts  of  the  partners 
may  be. 

7.  Partners  are  not  entitled  to  compensation  for  their 
services. 

8.  All  partners  have  an  equal  duty  to  keep  books  of 
account,  each  partner  having  free  access  thereto. 

Precedence  of  Claims  Against  Partnership 

While  it  is  true  that  an  individual  partner  who  has  ad- 
vanced money  to  the  partnership  or  expended  his  own 
money  for  its  benefit,  is  a  creditor  of  the  firm,  his  claims, 
nevertheless,  rank  after  those  of  the  outside  creditors  of 
the  concern ;  but  they  rank  before  the  claims  of  the  private 
creditors  of  his  copartners. 

An  undrawn  credit  account  appearing  in  the  books  of  a 
firm  to  the  benefit  of  one  of  the  partners,  is  not  to  be  con- 
sidered as  his  private  or  separate  estate  in  case  of  dissolu- 
tion of  the  copartnership,  until  the  firm's  debts  have  been 
paid.     This  is  all  the  more  essential  because  individual 


26  BUSINESS    ORGANIZATION 

creditors  of  a  partner  appear  to  have  a  preferred  equity 
in  the  separate  estate  of  that  partner  over  the  creditors  of 
the  firm. 

Value  of  the  Good- Will 

While  numerous  court  decisions  indicate  that  a  surviv- 
ing partner  has  the  right  to  continue  to  use  the  firm's 
name,  it  seems  to  be  a  generally  accepted  doctrine  that  if 
the  good-will  attaching  to  the  name  is  truly  existent  and 
has  a  value,  the  surviving  partner  is  not  entitled  to  use  it 
without  compensation  to  the  estate  of  the  deceased.  In 
some  cases  the  courts  have  even  gone  so  far  as  to  say  that 
the  basis  for  computing  the  value  of  the  good-will  which 
the  firm's  name  conveys,  should  be  the  annual  profits  of 
the  business  prior  to  the  death  of  the  partner.* 

Partnership  Paper 

If  negotiable  paper  is  within  the  scope  of  the  firm's 
business  any  one  member  may  issue  it;  if  not  within  the 
scope  its  issue  must  be  ratified  by  the  other  members  or 
it  is  not  binding  upon  the  firm.  The  same  is  true  of 
accommodation  paper,  guaranty,  and  suretyship. 

Status  of  Retiring  Partners 

If  a  retiring  partner  gives  his  ex-partners  an  uncondi- 
tional contract  of  sale,  he  retains  no  lien  against  the 
partnership  assets.  If  the  sale  is  conditional  upon  specific 
performances  he  retains  a  claim  upon  the  assets  available 
for  distribution  to  the  firm's  creditors. 

All  obligations  incurred  by  a  firm,  or  binding  upon 
partners  who  were  members  at  the  time  of  their  incur- 
rence, are  binding  upon  any  such  members  who  retire 
before  these  obligations  are  satisfied,  even  though  they 


•Matter  of  Silkman,  121  N.  Y.  App.  Div.  2oe;  105  N.  Y.  Suppl.  872;  affirmed 
in  190  N.  Y.;  560  N.  E. 


THE    COPARTNERSHIP 


27 


have  not  matured  at  the  time  of  such  retirement.  This 
holds  true  even  though  the  partners  who  purchase  the 
interests  of  those  who  retire  have  agreed  to  Hquidate  the 
liabiHties,  and  have  given  the  vendors  an  indemnity  bond 
against  any  HabiHty  for  the  firm's  debts.  The  law  con- 
siders retiring  partners  as  sureties  for  the  debts  incurred 
while  they  were  of  the  firm,  and  considers  the  bond  as  an 
indemnity  against  losses,  and  not  as  a  covenant  against 
liability  to  suit.* 

Status  of  Continuing  Partners 

The  continuing  partners  are  liable  for  the  debts  of 
the  old  firm,  jointly  with  the  retiring  partners.  If  a  new 
firm  has  been  organized  it  is  not  liable  unless  by  agree- 
ment to  become  so,  or  unless  it  performs  some  act  indi- 
cating that  it  intended  to  hold  itself  liable. 

Status  of  Incoming  Partners 

Partners  coming  in  after  the  retirement  of  other  part- 
ners, become  liable  for  the  debts  of  the  old  firm  only  if 
they  agree  to  undertake  such  liability,  or  if  they  perform 
an  act  indicating  such  intent.  And  it  may  be  considered 
that  they  agree  to  become  so  liable  if,  upon  entering  the 
firm,  they  fail  to  state  their  freedom  from  such  liability. 


*  Taliaferro  v.  Brown,  11  Alabama  702. 


CHAPTER   II 

THE    CORPORATION— STOCK    SECURITIES 

The  Corporation  Defined 

Chief  Justice  Marshall  thus  defines  a  corporation:* 
'An  artificial  being,  invisible,  intangible,  and  existing  only 
in  contemplation  of  law.  Being  the  mere  creature  of  law, 
it  possesses  only  those  properties  which  the  charter  of  its 
creation  confers  upon  it,  either  expressly  or  as  incidental 
to  its  very  existence.  These  are  such  as  are  supposed 
best  calculated  to  efifect  the  object  for  which  it  was 
created.  Among  the  most  important  are  immortality, 
and  if  the  expression  may  be  allowed,  individuality; 
properties  by  which  a  perpetual  succession  of  many  per- 
sons are  considered  as  the  same,  and  may  act  as  a  single 
individual.  They  enable  a  corporation  to  manage  its  own 
affairs,  and  to  hold  property  without  the  perplexing  intri- 
cacies, and  the  hazardous  and  endless  necessities  of  per- 
petual conveyances  for  the  purpose  of  transmitting  it 
from  hand  to  hand.  It  is  chiefly  for  the  purpose  of  cloth- 
ing bodies  of  men,  in  succession,  with  these  qualities  and 
capacities,  that  corporations  were  invented,  and  are  in 
use." 

Corporations  Classified 

Corporations  may  be  divided  into  stock  corporations 
and  non-stock  corporations.  Non-stock  corporations  in- 
clude all  chartered  associations  whose  purpose  is  idealistic, 
religious,  charitable,  educational,  etc.,  etc. 

*  Dartmouth  College  v.  Woodward,  (4  Wheat)  U.  S.  518-636;  4  L.  Ed.  6189. 

28 


STOCK    SECURITIES 


29 


Stock  corporations  are  frequently  divided  into: 

1.  Financial  Corporations 

2.  Business  Corporations 

3.  Public  Service  Corporations 

To  fulfil  the  purpose  for  which  they  are  created,  cor- 
porations require  capital;  this  is  either  contributed  by 
individuals,  copartnerships,  or  other  corporations,  or  is 
borrowed;  or  it  may  be  obtained  by  both  these  methods. 

Shares,  Capital,  and  Capital  Stock 

To  show  to  what  extent  individual  contributors  are 
interested  in  the  wealth  of  the  corporation  by  virtue  of 
their  respective  contributions,  "shares  of  capital  stock"  are 
issued  to  them,  having  a  "par"  or  nominal  value,  the 
minimum  of  which  is  fixed  by  statute,  the  maximum  being 
uniformly  $100.  In  the  State  of  New  York  it  is  now  legal 
to  issue  common  stock  without  a  par  value,  and  preferred 
stock  which  has  no  preference  as  to  principal,  may  also  be 
issued  without  par  value.* 

The  capital  contributed  by  interested  parties  is  the 
property  of  the  legal  entity  known  as  the  corporation, 
while  the  shares  of  stock  are  the  personal  property  of 
their  holders,  and  constitute  a  liability  of  the  corpora- 
tion. Thus,  when  we  refer  to  the  "capital"  of  a  corpora- 
tion we  mean  the  difference  between  the  assets  into  which 
the  contributions  of  capital  have  been  converted,  and  the 
liabilities  to  outsiders  incurred  as  a  result  of  the  activities 
of  the  corporate  being;  but  when  we  refer  to  "capital 
stock"  we  mean  the  actual  liability  of  the  company  to 
shareholders  for  the  capital  paid  in,  or  subscribed  and 
bound  under  the  law  to  be  paid  in;  and  in  addition  the 
"potential  stock,"  that  is  to  say  the  power  given  by  the 


*  See  Chapter  351  of  the  laws  of  New  York,  1912,  "An  act  to  amend  the 
stock  corporation  law  in  relation  to  corporations  having  shares  of  capital  stock 
without  nominal  or  par  value." 


30  BUSINESS    ORGANIZATION 

charter  to  obtain  more  capital  by  incurring  a  liability  to 
stockholders  to  the  full  extent  of  the  unissued,  but 
authorized  capitalization. 

Dividends 

The  profits  made  by  the  corporation  through  the 
employment  of  the  capital  contributed  by  the  share- 
holders, belong  to  the  latter  only  after  the  board  of  di- 
rectors has  resolved  that  they  shall  be  distributed  as  divi- 
dends and  the  resolution  has  become  known  outside  of  the 
board  room.  When  these  conditions  concur,  dividends 
become  debts  of  the  corporation,  and  the  shareholders  can 
enforce  their  payment.  In  business  corporations  it  is  cus- 
tomary to  separate  the  capital  stock  and  profits  by  calling 
the  latter  "surplus,"  Banks  and  financial  institutions, 
however,  frequently  refer  to  the  two  items  as  one,  "capital 
and  surplus."  This  is  due  to  the  fact  that  the  surplus  of 
banks  is  usually  considered  as  part  of  the  capital  stock 
and  that  the  transfer  or  the  bequest  of  bank  stock  is  under- 
stood to  carry  with  it  the  surplus  earned  which  has  not 
been  separated  therefrom  by  the  declarations  of  dividends. 

Kinds  of  Stock  and  Its  Issue 

The  capital  stock  of  corporations  is  usually  divided 
into  two  classes,  common  and  preferred.  Common  stock 
is  that  which  has  no  financial  preference  over  any  other 
stock  of  the  company  and  is  generally  that  to  which  is 
given  the  voting  power.  It  confers  upon  its  holders  the 
right  to  participate  in  the  management  of  the  affairs  of 
the  company  through  the  annual  election  of  a  board  of 
trustees,  or  directors,  who  are  to  act  for  the  stockholders 
at  large. 

The  word  "preferred,"  when  applied  to  stock,  means 
that  the  stock  is  entitled  to  first  consideration  in  the  dis- 


STOCK    SECURITIES 


31 


tribution  of  profits  and  assets,  either  or  both,  as  the  case 
may  be.  Preferred  stock  may  be  cumulative  as  to  divi- 
dends; it  may  or  it  may  not  have  voting  power,  be  re- 
deemable at  a  certain  figure  on  or  before  a  stated  period, 
or  be  convertible  into  bonds  of  the  corporation.  If  part 
of  the  original  organization  scheme,  the  issue  of  preferred 
stock  requires  no  authorization  on  the  part  of  the  com- 
mon stockholders;  but  if  it  is  to  be  issued  after  the  rights 
of  the  common  stockholders  have  been  established,  it 
requires  their  authorization. 

Corporate  capital  stock  is  issued  in  exchange  for  a  con- 
sideration, the  nature  of  which  varies  according  to  the 
statutes  of  individual  states,  but  which  may  be  said  to  be, 
in  the  majority  of  the  states: 

(i)   Cash  or  its  equivalent,  the  latter  term  including 
subscriptions  subject  to  call. 

(2)  Property,  the  valuation  of  which  it  is  within  the 

power  of  the  board  of  directors  to  establish. 

(3)  Labor  or  services. 

Stock  Subscriptions 

Generally  speaking,  unconditional  subscriptions  to  cap- 
ital stock  bind  the  subscribers,  i.e.,  they  can  be  enforced; 
the  issue  of  certificates  of  stock  upon  the  strength  of  a 
subscription  agreement,  completes  the  stockholder's  lia- 
bility, and  he  is  bound  to  pay  that  which  he  has  promised 
to  pay.  This  liability  of  the  stockholder  is  enforceable  by 
the  company  itself,  or  by  its  creditors  after  insolvency. 
Courts  have  held  that  unless  particular  statutes  provide  to 
the  contrary,  "it  is  not  essential  that  a  certificate  should 
have  been  issued,  in  order  to  create  the  relation  of  share- 
holder, provided  a  contract  to  take  the  stock  has  been 
duly  made." 

It  is  said  that  the  form  of  subscription  is  immaterial, 


„  BUSINESS    ORGANIZATION 

so  long  as  the  intention  of  the  parties  can  be  ascertained; 
but  in  cases  where  the  statutes  require  that  a  certain  per 
cent  of  the  subscriptions  be  paid  in  cash  upon  subscribing, 
such  a  payment  must  be  made  before  the  subscription 
agreement  becomes  binding. 

Capital  stock  to  which  a  prospective  stockholder  has 
subscribed,  but  for  which  he  has  not  paid,  can  be  declared 
forfeited  only  if  the  statutes  of  the  state  in  which  the  cor- 
poration was  created,  specifically  grant  the  power  of  for- 
feiture. Even  then,  the  exercise  of  this  corporate  right 
should  be  for  the  benefit  of  the  corporation,  and  not  for 
that  of  the  stockholders.  And  this  right  can  be  exercised 
only  by  the  board  of  directors.  If  the  statutes  do  not  pro- 
vide for  forfeiture,  the  existence  of  a  provision  to  that 
effect  in  the  by-laws  of  the  company  is  invalid. 

The  acceptance  by  a  corporation  of  a  subscription  to 
its  capital  stock,  makes  the  subscriber  a  stockholder  of  the 
company.  Bona  fide  purchasers  of  capital  stock  which 
bears  on  the  face  of  its  certificate  a  notice  that  it  is  fully 
paid,  are  not  liable  either  to  the  corporation  or  to  its 
creditors  for  any  amount  thereof  which  might,  in  truth, 
be  unpaid. 

Property  Acquired  by  Stock  Issue 

The  law  of  New  York  says  in  regard  to  the  matter  of 
consideration  for  stock,  that  any  corporation  authorized 
by  its  charter  to  purchase  property  for  its  use  and  lawful 
purposes,  may  issue  full-paid  non-assessable  stock  for  the 
value  of  the  said  property,  and  that  in  the  absence  of 
fraud,  the  judgment  of  the  directors  in  regard  to  the  value 
of  the  property  thus  acquired  shall  be  conclusive.  It  also 
requires  that  whenever  a  corporation  reports  on  its  capital 
stock  in  compliance  with  legal  provisions,  it  shall  specify 
what  amount  of  stock  was  issued  for  property.  Unless 
prohibited  by  statute,  corporations  may  acquire  property 


STOCK    SECURITIES  33 

by  paying  therefor  partially  in  stock  and  partially  in  bonds 
and  partially  in  cash. 

Labor  or  Services  as  a  Consideration 

Labor  is  thought  to  include  manual  or  brain  labor  con- 
tributed by  contractors,  lawyers,  financial  interests,  etc., 
etc.,  for  the  benefit  of  the  corporation,  and  anything 
which  the  corporation  receives  in  the  line  of  services  for 
which  it  would  have  to  pay.  Under  this  interpretation  of 
the  law,  it  would  be  possible  to  issue  stock  for  organiza- 
tion expenses,  for  alterations  to  buildings,  for  the  particu- 
lar services  rendered  by  underwriters  of  corporate  stocks 
and  bonds,  etc.,  etc. 

Stock  Bonuses — Increase  or  Decrease  of  Capital  Stock 

In  general,  it  is  held  that  a  corporation  cannot  issue 
its  shares  to  its  stockholders  as  a  bonus;  but  in  the  State 
of  New  York  the  issue  of  unissued  stock  as  a  bonus  to 
bondholders  has  been  upheld  as  proper,  since  it  was  neces- 
sary to  the  successful  flotation  of  bonds.*  The  Supreme 
Court  of  the  United  States  has  corroborated  the  sound- 
ness of  this  principle  to  the  extent  of  a  decision  to  the 
effect  that  where  a  bondholder  had  obtained  stock  as  con- 
sideration for  his  purchase  of  bonds  at  par,  he  could  not 
be  made  to  pay  for  the  stock,  provided  the  par  value  of 
the  bonds  was  greater  than  the  actual  value  of  the  bonds 
and  stocks. t 

Capital  stock  may  be  increased  beyond  the  issue 
originally  authorized,  by  compliance  with  the  requirements 
of  the  state  statutes.  It  may  be  similarly  decreased,  but 
there  is  often  a  statutory  provision  that  the  reduced  capi- 
tal stock  shall  at  least  equal  the  debts  of  the  corporation. 


•  Christensen  v.  Enu,  106  N.  Y.  97;  12  N.  E.  648;  8  N.  Y.  St.  681;  60  Am. 
Rep.  429. 

t  Handley  v.  Stutz,  139  U.  S.  417;  11  S.  Ct.  530- 


24  BUSINESS    ORGANIZATION 

The  statutes  of  individual  states  must  be  consulted  in  re- 
gard to  what  constitutes  the  proper  legal  steps  necessary 
to  obtain  the  authorization  to  increase  or  decrease  the 
capital  stock. 

Borrowed  Capital — Corporate  Bonds 

While  the  issue  of  long-time  instruments  of  credit  is 
not  a  prerogative  which  only  corporations  enjoy,  bonds 
are  almost  exclusively  issued  by  corporate  bodies.  Unlike 
stock,  they  promise  to  pay  a  certain  sum  of  principal  and 
a  certain  sum  of  interest  at  specified  times;  and,  unlike 
stock,  they  give  their  holders  the  privilege  of  asserting 
their  rights  whenever  that  which  they  are  entitled  to  has 
not  been  received.  But  since  this  right  of  the  bondholders 
appears  to  place  in  jeopardy  the  preexisting  rights  of 
stockholders,  many  states  require  that  all  issues  of  bonds 
be  authorized  by  a  two-thirds  vote  of  the  stockholders. 

Bonds  are,  generally  speaking,  long-time  promissory 
notes  bearing  interest  at  a  stated  rate,  issued  serially  in 
units  of  like  denomination,  payable  to  bearer  or  to  a 
person  registered  on  the  books  of  the  company  issuing 
them,  pledging  to  the  aggregate  of  the  bondholders  cer- 
tain specific  properties  described  cursorily  in  the  note 
itself,  and  in  full  detail  in  the  contract  which  gives  the 
trustee  the  right  to  sell  the  pledge  for  the  benefit  of  the 
holders  of  the  notes  if  either  principal  or  interest  is  de- 
faulted at  maturity. 

Classification  of  Bonds  as  to  Security 

There  are,  however,  certain  classes  of  bonds  which  may 
or  may  not  pledge  property  to  secure  the  principal  of  the 
note,  and  which  pledge  no  property  whatever  to  secure 
the  interest.  Bonds  may  thus  be  divided  into  three  gen- 
eral classes: 


STOCK    SECURITIES 


35 


1.  Secured  Bonds 

a.  Pledging  personal  property 

b.  Pledging  real  property 

c.  Pledging  both  real  and  personal  property 

2.  Partly  Secured  Bonds 

a.     Unsecured  as  to  interest  but 

Secured  or  preferred  as  to  principal 

3.  Unsecured  Bonds  both  as  to  principal  and  as  to 

interest 

I.    Secured  Bonds 

a.    Pledging  Personal  Property: 

(i)  Debenture  Bonds  of  Financial  Institutions.  These 
bonds  pledge  first  mortgages  owned  by  the  company 
which  issues  the  instruments  of  credit.  The  rate  of  inter- 
est which  these  bonds  carry  is,  of  course,  less  than  the 
borrowing  company  obtains  on  its  own  investments  in 
first  mortgages. 

(2)  Collateral  Trust  Bonds.  The  pledge  in  this  case 
consists  of  personal  property,  such  as  stocks,  bonds,  mort- 
gages, etc.,  owned  by  the  borrowing  company,  and  placed 
by  it  in  the  hands  of  a  trustee,  in  accordance  with  the 
terms  of  a  contract  which  provides  for  the  sale  of  the 
pledge  for  the  benefit  of  the  bondholders,  upon  default  by 
the  borrower  of  either  principal  or  interest. 

(3)  Equipment  Bonds.  Until  recent  years,  the  form 
of  these  bonds  did  not  vary  materially  from  that  of  other 
bonds.  They  were  issued  for  periods  running  from  ten  to 
fifteen  years,  and  were  repayable  in  total  at  maturity. 
They  pledged  the  very  equipment  for  the  acquisition  of 
which  they  had  been  issued.  Lately  these  bonds  have 
assumed  a  character  which  places  them  in  a  class  by  them- 
selves. They  are  known  as  "Car  Trust"  or  "Equipment 
Trust  Certificates."  They  are  frequently  repayable  in  in- 
stalments, the  security  pledged  under  the  issue  as  a  whole 


^5  BUSINESS    ORGANIZATION 

reverting,  after  payment  of  each  instalment,  to  the  unre- 
tired  proportion.  The  equipment  pledged  by  the  inden- 
ture is  earmarked  individually  by  means  of  a  plate  bear- 
ing the  name  of  the  trustee  in  whom  title  rests  until  pay- 
ment of  all  the  obligations  under  the  issue.  When  re- 
payable in  instalments,  they  are  issued  in  series  marked 
"A,"  "B,"  "C,"  etc. 

b.  Pledging  Real  Property: 

(i)  Real  Estate  Bonds.  When  issued  by  public  service 
corporations,  these  bonds  are  secured  by  such  parcels  of 
real  estate  as  are  not  required  for  the  operations  of  the 
company.  When  issued  by  other  companies,  the  above 
distinction  does  not  necessarily  apply. 

(2)  Land  Grant  Bonds.  The  pledge,  under  these  in- 
struments of  credit,  is  the  landed  estate  which  common 
carriers  receive  sometimes  as  a  donation,  either  from  the 
government,  from  municipalities,  or  from  large  business 
interests,  in  consideration  of  the  value  of  the  pubHc 
services  which  they  render. 

(3)  Terminal  Bonds.  These  pledge  the  land  and  the 
buildings  which  constitute  what  is  generally  known  as  the 
"terminal  facilities"  of  transportation  companies. 

c.  Pledging  Both  Real  and  Personal  Property: 

(i)  General  Mortgage  Bonds.  They  offer  as  a  secur- 
ity the  whole  physical  property  of  the  company,  present  or 
to  come,  whether  real  or  personal. 

(2)  Blanket  Mortgage  Bonds.  They  cover  the  whole 
property  of  a  railroad  system,  subject  to  such  prior  liens  as 
attach  to  parts  thereof.  If  they  contain  specific  provisions 
compelling  the  retirement  of  prior  liens  at  maturity,  they, 
in  time,  become  first  mortgages;  otherwise,  not. 

(3)  Divisional  Bonds.  These  are  special  to  railroads 
which,  in  the  course  of  their  development,  have  absorbed 


STOCK    SECURITIES 


37 


other  lines  now  forming  subdivisions  of  the  system  as  a 
whole.  The  bonds  which  mortgaged  the  property  at  the 
time  of  its  absorption  by  the  greater  system,  are  known 
as  "divisional." 

(4)  Purchase  Money  Mortgage  Bonds.  These  bonds 
pledge  the  very  property  for  the  partial  payment  of  which 
they  were  issued. 

2.  Partly  Secured  Bonds 

a.  Income  Bonds.  The  mortgage  recites,  either  that 
there  is  pledged  some  specific  property  as  a  security  for 
the  repayment  of  the  principal,  or  merely  that  the  bonds 
constitute  a  preference  claim  on  the  property  of  the  com- 
pany. As  to  the  interest  on  the  bonds,  its  payment  de- 
pends entirely  upon  the  existence  of  net  profits;  if  net 
profits  do  not  exist  in  any  given  period,  the  right  of  the 
bondholders  may  or  may  not  cumulate,  according  to  the 
terms  of  the  indenture. 

3.  Unsecured  Bonds 

a.  Railroad  Debentures.  These  bonds  are  nothing 
more  than  a  formal  acknowledgment  of  a  debt,  under  seal. 
In  regard  to  the  interest  payable  thereunder,  they  present 
the  same  general  characteristics  as  income  bonds. 

Typical  Bond  Issues 

In  regard  to  their  ultimate  disposition,  bonds  are  often 
referred  to  as  "redeemable"  and  "convertible,"  while  the 
names  borne  by  certain  other  bonds  indicate  that  they 
came  into  existence  as  a  result  of  financing  operations  the 
nature  of  which  is  shown  by  the  title  appended  to  the  in- 
struments. To  the  latter  category  belong,  consolidated 
bonds,  refunding  bonds,  and  interest  bonds. 

Redeemable  bonds  can  be  repaid  by  the  company 
liable  under  them,  at  the  end  of  a  period  shorter  than  the 

79505 


38 


BUSINESS    ORGANIZATION 


life  indicated  on  their  face.  The  right  of  redemption  be- 
fore maturity  belongs  to  the  maker,  and  not  to  the  bond- 
holder. 

Bonds  are  said  to  be  convertible  when,  according  to 
the  terms  of  the  indenture,  they  can  be  exchanged,  at  the 
option  of  the  holder  issuing  them,  for  some  other  form 
of  obligation,  such,  for  instance,  as  preferred  stock. 

An  issue  of  consolidated  bonds  takes  the  place  of  sev- 
eral prior  issues,  and  consolidates  the  pledges  g^ven  as  a 
security  for  the  individual  issues  to  be  retired. 

Refunding  bonds,  as  their  name  indicates,  are  issued 
in  lieu  of  maturing  obligations;  they  may  either  be  ex- 
changed for  the  maturing  bonds,  or  sold  in  order  that  the 
proceeds  may  be  applied  to  the  retirement  of  the  obliga- 
tions. In  either  case,  the  same  property  is  pledged  as  ap- 
plied to  the  redeemed  instruments. 

Interest  bonds,  as  their  name  suggests,  are  issued  in 
payment  of  interest  obligations  maturing  under  other 
bonds  which  cannot  be  met  otherwise. 

Bonds  may  carry  as  many  interest  coupons  as  there 
are  interest  periods  during  their  life,  or  they  may  carry  no 
coupons  at  all.  In  the  first  instance,  they  are  called 
coupon  bonds;  in  the  second  instance,  they  are  known  as 
registered  bonds. 


CHAPTER  III 

THE    CORPORATION— ORGANIZATION    AND 
MANAGEMENT 

Corporate  By-Laws 

As  it  would  be  manifestly  impossible  for  the  stock- 
holders to  manage  the  affairs  of  the  corporation,  and  as, 
besides,  they  are  not  recognized  by  law  as  agents  of  the 
corporate  body,  they  elect  a  board  of  directors  whose  duty 
it  is  to  manage  the  corporate  affairs.  This  board  exercises 
its  functions  by  appointing  officers  to  whom  it  delegates 
part  of  its  powers;  and  in  order  that  the  rights  and  duties 
of  all  may  be  well  defined  and  understood,  by-laws  are 
enacted  which,  in  so  far  as  they  do  not  conflict  with  the 
laws  of  the  land,  are  the  laws  regulating  the  relations  of 
the  stockholders  with  the  directors,  of  the  directors  with 
the  stockholders  and  officers,  and  in  some  cases  of  the 
corporation  with  outsiders  who  have  knowledge  of  the 
existence  and  import  of  the  by-laws  and  are  thus  supposed 
to  accept  their  validity.  Unless  vested  in  the  board  of 
directors  by  the  statutes  of  the  particular  state  in  which 
the  corporation  is  formed,  or  by  the  charter  of  the  cor- 
poration, the  right  to  make  by-laws  belongs  to  the  stock- 
holders. 

The  Board  of  Directors 

Speaking  generally,  after  the  stockholders  have  elected 
a  board  of  directors,  they  cannot  act  otherwise  than 
through  that  board;  and  in  the  absence  of  restricting  by- 

39 


.-,  BUSINESS    ORGANIZATION 

40 

laws  the  board  has  practically  the  same  powers  as  the  cor- 
poration. Directors  do  not,  however,  possess  the  right  to 
encroach  upon  powers  that  have  been  given  to  stock- 
holders by  statute,  such,  for  instance,  as  the  right  to  re- 
move a  director,  to  increase  or  decrease  capital  stock,  to 
dissolve  the  company,  etc.  They  cannot,  unless  authorized 
by  statute,  amend  by-laws,  or  make,  without  consent  of 
the  stockholders,  any  change  in  the  authorized  capital 
stock  of  the  company.  If  the  corporation  has  that  power, 
the  directors  may  direct  the  purchase  of  the  company's 
capital  stock  in  the  open  market,  and  hold  it  in  the  treas- 
ury subject  to  resale,  but  they  cannot  order  it  canceled; 
they  must  hold  it  unextinguished.  They  cannot  cancel 
subscriptions  to  stock  without  consent  of  the  stock- 
holders; issue  more  stock  than  is  authorized;  execute 
leases  which  amount  practically  to  divesting  the  corpora- 
tion of  its  physical  assets;  issue  stock  for  less  than  par, 
unless  the  statutes  permit  of  the  contrary;  declare  unlaw- 
ful dividends,  or  vote  by  proxy  at  meetings  of  the 
directors. 

The  directors  possess  the  power  to  borrow  money 
and  to  pledge  therefor  the  assets  of  the  company,  except  • 
when  the  by-laws  prohibit  it ;  to  create  new  debts  to  pay 
off  old  debts;  to  lease  corporate  property  if  such  lease  does 
not  deprive  the  corporation  of  the  power  to  conduct  its 
own  business;  to  use  their  discretion  as  to  the  extent  of 
the  dividends  to  be  paid  out  of  the  surplus  earned;  to 
conduct  corporate  litigation  at  the  expense  of  the  cor- 
poration; to  ratify  a  debt  which  has  been  barred  by  the 
statute  of  limitation;  to  make  and  transfer  negotiable 
paper;  to  fix  the  salaries  of  the  corporate  officers;  to  pay 
wages  in  advance;  and,  unless  prevented  by  the  corporate 
by-laws,  to  make  contracts  for  periods  of  one  year  or  more, 
with  persons  who  have  services  to  hire  or  to  sell. 


CORPORATE  ORGANIZATION  AND  MANAGEMENT 


41 


Courts  of  equity  are  prone  to  consider  directors  as  the 
trustees  of  the  stockholders  as  well  as  of  the  creditors  of 
the  corporation.  This  gives  to  their  functions  a  fiduciary 
character  which  places  them  in  a  position  where  they 
may  not  secure  for  themselves  any  advantage  which  the 
stockholders  cannot  share,  or  which  would  cause  the 
rights  of  the  creditors  to  become  inferior  to  theirs.  It  has 
even  been  held  that  a  director  who  acquires  for  himself 
property  which  it  was  his  duty  to  acquire  for  the  corpora- 
tion, holds  it  as  a  trustee  for  the  corporation  precisely  as 
if  he  had  acquired  property  belonging  to  the  corporation.* 

Stockholders 

Stockholders  have  the  common-law  right  to  make  the 
by-laws  of  the  corporation.  In  some  states  the  statutes 
delegate  the  right  to  the  board  of  directors.  They  may 
insist  upon  certificates  of  stock  being  issued  to  them  as 
evidence  of  the  liability  which  the  corporate  entity  has 
contracted  towards  them.  In  some  states  they  are 
authorized  to  issue  preferred  stock  by  appropriate  proce- 
dure. They  have  a  common-law  right  to  inspect  the  rec- 
ords of  the  company,  but  this  has  been  restricted  by 
statute  and  by  the  courts,  and  usually  a  good  reason  for 
such  inspection  must  be  shown.  A  stockholder  has  the 
right  to  subscribe  to  his  due  proportion  of  all  increases 
of  capital  stock.  Unless  the  S'tatutes  or  the  by-laws  of  the 
company  specifically  authorize  mortgages  by  a  vote  of  the 
directorate,  the  directors  cannot  jeopardize  the  rights  of 
the  stockholders  by  issuing  such  obligations  without  the 
authorization  of  at  least  two-thirds  of  the  stockholders 
assembled  at  a  special  meeting. 

In  the  event  of  insolvency  the  stockholders  are  liable 
for  the  difference  between  that  which  they  have  paid,  and 
that  which  they  should  have  paid  to  make  their  stock 

*  Robinson  v.  Jewett,  116  N.  Y.  40;  22  N.  E.  224. 


.,  BUSINESS    ORGANIZATION 

"full-paid,"  even  though  the  company  had  agreed  to  ac- 
cept the  payments  made  as  full  consideration. 

Corporate  Officers 

The  number,  the  titles,  and  the  powers  of  the  cor- 
porate officers,  vary  materially  according  to  the  im- 
portance and  to  the  internal  organization  of  corporations. 
They  are,  usually:  the  president,  one  or  several  vice-presi- 
dents, the  secretary,  the  treasurer,  and  the  auditor. 

The  President.  In  corporations  in  which  the  board  of 
directors  is  active,  the  president  exercises  merely  the 
functions  of  an  officer  presiding  over  the  deliberations  of 
that  body,  and  of  the  meetings  of  stockholders.  In  cor- 
porations where  the  board  is  inactive,  the  president  has 
the  power  of  a  general  agent  of  the  corporation.  The 
nature  of  this  power  depends  upon  the  character  of  the 
particular  enterprise,  and  upon  business  custom. 

The  Vice-President.  This  officer  has,  at  law,  no  special 
function  or  power,  except  when  taking  the  place  of  the 
president.  Corporate  by-laws  may,  however,  render  his 
office  active  and  important. 

The  Secretary.  The  duties  and  importance  of  the  sec- 
retary's office  is  determined  by  the  corporate  by-laws. 
Generally  speaking,  he  signs  certificates  of  stock,  keeps 
the  corporate  seal  and  the  corporate  records,  reports  the 
deliberations  of  the  board  of  directors  and  of  the  meetings 
of  stockholders.  He  signs  or  attests,  or  both,  all  sealed 
instruments  of  the  corporation,  and  issues  all  official 
notices  of  meetings. 

The  Treasurer.  As  the  name  indicates,  the  treasurer 
has  charge  of  the  corporate  finances.  He  usually  has  the 
power  to  sign  checks,  to  select  depositories  when  the 
board  has  not  acted,  and  to  sign  jointly  with  the  presi- 
dent, or  other  officer,  all  instruments  pertaining  to 
finances. 


CORPORATE  ORGANIZATION  AND  MANAGEMENT 


43 


The  Auditor.  This  officer  has  charge  of  all  matters 
pertaining  to  the  keeping  of  the  financial  records.  He 
plans  books  of  account,  devises  methods  of  recording  and 
accounting  best  calculated  to  fulfil  the  purpose  of  the 
company,  and  watches  over  the  faithful  recording  of  all 
facts.  He  submits,  at  stated  periods,  statements  showing 
the  financial  status  of  the  enterprise,  and  the  causes  which 
have  contributed  to  its  success  or  to  its  failure. 


CHAPTER   IV 

THE  CORPORATE  RECORDS 

Statutory  Requirements 

The  financial  records  which  a  concern  may  keep— 
whether  partnership  or  corporation — will  be  considered  at 
length  in  the  course  of  this  book.  But  inasmuch  as  the 
corporate  books  have  little  to  do  with  accounting  prin- 
ciples, it  may  be  well  to  treat  of  them  at  this  point. 

The  requirements  in  regard  to  the  number  and  form 
of  corporate  books  vary  greatly  in  the  different  states.  Gen- 
erally speaking,  it  may  be  said  that  the  scheme  of  corporate 
accounting  comprises : 

I.     Minute  Book 


Subscription  Ledger 
Stock  Certificate  Book 
Stock  Book  or  Stock  Ledger 
Corporate  or  Stock  Journal 
Stock  Transfer  Book 


I.    Minute  Book 

The  minute  book  should  record  the  facts  in  connection 
with  the  organization  of  the  company,  the  framing  and  the 
amendment  of  the  by-laws,  the  election  of  the  directors, 
the  appointment  of  officers  and  ministerial  agents,  and  a 
true  history  of  the  meetings,  deliberations,  and  resolutions 
of  the  board  of  directors  and  of  the  stockholders.  The 
facts  recorded  should  be  expressed  in  clear,  unequivocal 
language.    The  book  is  usually  kept  by  the  secretary  of 

44 


THE    CORPORATE    RECORDS 


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BUSINESS    ORGANIZATION 


the  company;  it  has  no  special  form,  and  may  consist  of  a 
scrap-book  in  which  the  minutes  are  pasted  after  having 
been  typewritten.  A  loose-leaf  minute  book  is  the  most 
convenient  form. 

a.    Subscription  Ledger 

When  the  subscriptions  to  capital  stock  are  numerous, 
and  subject  to  calls  extending  over  a  period  of  several 
months,  it  is  necessary  that  an  account  be  kept  with  every 
subscriber  and  every  instalment.  The  arrangement  of  the 
ledger  in  which  these  accounts  will  be  kept  is  essentially 
a  matter  of  convenience.  It  may  be,  for  instance,  as 
shown  in  Figure  i. 

3.    Stock  Certificate  Book 

This  book,  which  must  be  bound,  contains  the  blank 
certificate  to  be  issued;  each  certificate  is  attached  to  a 
stub,  a  perforated  line  running  vertically  between  the  two 
parts  of  the  document. 


Binding  Stub  j  Certificate 


Figure  2.    Arrangement  of  Stock  Certificate  Book 

The  stub  contains  reference  to  the  number  of  the 
certificate,  the  amount  of  shares  which  it  stands  for,  the 
date  of  issue,  and  the  name  and  address  of  the  stockholder. 
It  may  state  the  consideration  for  the  issue,  or  merely  the 
fact  that  the  stock  was  part  of  an  "Original  Issue."  It 
provides  for  the  necessary  information  in  connection  with 
registered  transfers  of  stock  from  a  stockholder  to  an- 


THE    CORPORATE    RECORDS  47 

Other,  for  the  signature  of  the  stockholder  receiving  the 
certificate  which  corresponds  to  the  stub,  and  for  the  date 
of  delivery. 

Certificate  No.  140 
No.  of  Shares  50 
Issued: 

On  May  I,  1912 
To  John  Doe 
Address:    Astoria,  L.  I. 
For :    Property 
From  whom  transferred: 

Name 

Address 

Date 

No.  of  Original  Certificate 

No.  of  shares  of  Original  Certificate 

No.  of  shares  transferred 

Received  Certificate  No.  140  for  50  shares 

Date,  May  1,  1912 
Signature  John  Doe 

Figure  j.    Stock  Certificate  Stub 

The  certificate  itself  is  a  more  or  less  elaborate  docu- 
ment, bearing  the  name  of  the  issuing  company,  reciting 
the  authorized  issue  of  which  it  is  part,  the  class  of  stock 
which  it  represents  (preferred  or  common),  stating 
whether  or  not  it  is  full-paid  and  non-assessable,  and  the 
par  value  of  each  share.  If  the  stock  is  preferred,  the 
certificate  may  recite  the  details  of  the  issue. 

The  stock  certificate  certifies,  under  the  common  seal 
of  the  corporation  and  the  signatures  of  authorized  offi- 
cers, that  the  person  whose  name  appears  on  its  face  is  the 
owner  of  so  many  shares  of  capital  stock  of  the  company. 
It  states  the  conditions  under  which  it  is  transferable,  and 
bears  on  its  back  a  blank  form  for  the  assignment  of  the 
stock. 


48 


BUSINESS    ORGANIZATION 


4.  Stock  Book  or  Stock  Ledger 

The  stock  book  (Figs.  4-7)  must  be  so  arranged  as  to 
comply  with  the  provisions  of  the  statutes  of  the  particu- 
lar state  in  which  the  corporate  charter  was  granted.  The 
law  of  the  State  of  New  York  requires  that  the  book  con- 
tain the  names,  alphabetically  arranged,  of  all  persons  who 
are  stockholders  of  the  corporation,  showing  their  places 
of  residence,  the  number  of  shares  of  stock  held  by  them 
respectively,  the  time  when  they  respectively  became  the 
owners  thereof,  and  the  amount  paid  thereon.  It  also  re- 
quires that  the  stock  book  shall  be  open  daily,  during  at 
least  three  business  hours,  for  the  inspection  of  its  stock- 
holders and  judgment  creditors,  who  may  make  extracts 
therefrom. 

The  keeping  of  a  Capital  Stock  Balance  account  in  the 
stock  book,  as  shown  in  Figure  4,  is  not  required  by  law, 
nor  is  it  necessary  to  meet  the  demands  of  the  stock- 
holders and  judgment  creditors;  it  has,  nevertheless,  the 
advantage  of  making  the  stock  book  self-balancing,  and 
of  corroborating  the  accuracy  of  the  financial  ledger  in 
connection  with  the  amount  of  capital  stock  issued  and 
outstanding.  The  crediting  of  the  shares  issued  to  the 
account  of  the  individual  creditors,  is  not  a  matter  of  ac- 
counting principles;  it  is,  however,  a  matter  of  common 
sense,  since  the  corporation  is  liable  to  the  stockholder  for 
the  capital  stock  issued  to  him. 

5.  Corporate  (or  Stock)  Journal 

This  book  (Figure  8)  is  used  only  by  corporations 
whose  stock  is  very  active.  It  makes  it  possible  to  gather 
daily  the  capital  stock  transactions  which  have  taken  place 
both  at  the  office  of  the  company  and  at  the  offices  of  the 
duly  appointed  transfer  agents,  and  to  transfer  them 
quickly  and  accurately  to  the  capital  stock  ledger.  The 
accounting  is  done  in  shares,  not  in  money  amounts. 


THE    CORPORATE    RECORDS 


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THE    CORPORATE    RECORDS 


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THE    CORPORATE    RECORDS 


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6.     Stock  Transfer  Book 

The  law  of  New  York  prescribes  that : 

Every  corporation  or  its  transfer  agent  shall  keep  a 
just  and  true  book  of  account  in  the  form  prescribed  by 
the  comptroller,  wherein  shall  be  plainly  and  legibly 
recorded  in  separate  columns: 

1.  The  date  of  making  every  transfer  of  stock 

2.  The  name  of  the  stock  and  the  number  of  shares 

thereof 

3.  The  serial  number  of  each  surrendered  certificate 

4.  The  serial  number  of  the  certificate  issued  in  ex- 

change therefor 

5.  The  number  of  shares  represented  by  said  certifi- 

cate 

6.  The  name  of  the  party  to  whom  said  certificate 

was  issued 

7.  The   number   and   face   value   of   the   adhesive 

stamps  as  affixed  and  required  by  the  statute 

It  shall  also  keep  and  retain  a  stock  certificate  book 
and  all  surrendered  or  canceled  shares  or  certificates  of  its 
stock  and  memoranda  relating  to  the  sale  thereof,  for  a 
period  of  two  years  from  the  date  of  the  delivery  thereof. 

The  requirements  as  to  the  stock  transfer  book  vary 
in  the  different  states.  In  New  York  the  prescribed  form  of 
stock  transfer  book  to  be  kept  by  corporations  and  transfer 
agents  is  shown  on  the  preceding  page. 


Part  II— The  General  Theory  and  Technique 
of  Accounts 


CHAPTER  V 

ACCOUNTING  SYSTEMS— SINGLE  ENTRY 

The  Principles  of  Single  Entry  ^ 

The  purpose  of  single-entry  bookkeeping  isito  record 
all  the  transactions  of  a  business,  but  to  keep  running 
ledger  accounts  with  persons  only;  that  is  to  say,  with  the 
proprietor,  the  persons  who  enter  into  business  relations 
with  him  (his  customers),  and  the  persons  with  whom  he 
enters  into  business  relations  (his  creditors).  To  other 
invested  values,  not  found  in  the  ledger  but  ascertainable 
by  means  of  analysis  of  books  of  first  record  or  through 
periodical  inventories,  is  left  the  duty  of  reflecting,  at  the 
end  of  the  accounting  period,  the  increases  and  decreases 
which  they  have  individually  received  or  suffered. 
The  basic  principles  of  the  system  are: 

1.  Increases  of  positive  values  (assets),  plus  decreases 
of  negative  values  (liabilities),  as  revealed  by  inventories 
and  by  the  accounts  with  persons,  give  all  the  factors 
which  have  increased  the  wealth  of  the  proprietor. 

2.  Decreases  of  positive  values,  plus  increases  of  neg- 
ative values,  as  revealed  by  inventories  and  by  the  ac- 
counts with  persons,  give  all  the  factors  which  have  de- 
creased the  wealth  of  the  proprietor. 

54 


SINGLE    ENTRY 


55 


3.  Decreases  of  positive  values,  plus  increases  of  nega- 
tive values,  represent  the  resources  which  the  proprietor 
has  applied  to  obtain  the  factors  which  have  contributed 
to  the  net  increase  of  his  wealth. 

Single-Entry  Ledger  Accounts 

Running  ledger  accounts  with  persons  are  to  be  so 
kept  as  to  show  clearly: 

1.  For  the  Proprietor: 

a.  The  net  amount  of  the  values  originally  in- 

vested by  him  in  the  business,  represent- 
ing what  he  owns  or  is  due  to  him,  minus 
what  he  owes. 

b.  The   increases   or   decreases   of  the  values 

originally  invested  by  him,  resulting  from 
the  operations  of  the  accounting  period. 

2.  For  the  Customers  and  Creditors: 

a.  The  amount  receivable  from  them  or  pay- 

able to  them  by  the  proprietor,  at  the  in- 
cipiency  of  their  business  relations  with 
him. 

b.  The  changes  occurring  in  the  indebtedness 

of  the  parties  as  a  result  of  the  operations 
of  the  accounting  period. 

Debits  and  Credits 

Under  the  rules  of  bookkeeping  by  the  single-entry 
system,  the  proprietor  credits  his  capital  account,  at  the 
beginning  of  business,  with  his  net  investment.  There- 
after, the  increases  or  decreases  of  the  personal  accounts 
of  the  proprietor,  of  the  customers,  and  of  the  creditors, 
are  recorded  in  the  ledger  by  means  of  debits  and  credits 
to  the  accounts,  as  indicated  by  the  day  book  (or  journal), 
which  contains  the  daily  recital  of  all  the  transactions. 


e6   THEORY  AND  TECHNIQUE  OF  ACCOUNTS 

By  debit,  is  meant : 

1.  The  recording  by  the  proprietor,  in  a  ledger  ac- 

count with  a  person,  of  claims  against  that 
person  arising  from  the  sale  of  merchandise. 

2.  The  recording  by  the  proprietor,  of  the  reduction, 

or  of  the  settlement  in  full,  of  a  claim  payable 
to  a  person  who  has  extended  credit  to  him  for 
merchandise  purchased. 

3.  The  recording  by   the   proprietor,   in   his   own 

account,  of  the  net  decrease  of  the  values  in- 
vested by  him. 
By  credit,  is  meant : 

1.  The  recording  by  the  proprietor,  of  the  reduc- 

tion, or  of  the  settlement  in  full,  of  his  claim 
against  a  customer,  arising  from  the  receipt  of 
money  or  its  equivalent. 

2.  The  recording  by  the  proprietor,  of  a  debt  which 

he  has  incurred  through  purchase  on  credit. 

3.  The  recording  by  the  proprietor,  in  his  own  ac- 

count, of  the  net  increase  of  the  value  invested 
by  him. 

The  Effect  of  Debits  and  Credits 

Crediting  the  proprietor's  account  with  his  net  invest- 
ment at  the  beginning  of  operations,  gives  precisely  the 
same  result  as  crediting  him  with  his  assets  and  debiting 
him  with  his  liabilities. 

Debiting  a  customer  with  a  claim  against  him  of,  say, 
$60  obtained  in  exchange  for  merchandise  costing,  say, 
$40,  sold  to  him  on  credit,  gives  the  same  result  as  debit- 
ing the  proprietor  with  the  cost  of  the  merchandise  which 
has  gone  out  of  the  business,  and  crediting  him  with  the 
new  value  (representing  the  cost  of  the  value  parted  with, 
plus  profits  on  sale)  which  has  come  into  the  business 
under  the  form  of  a  claim  against  a  person. 


SINGLE    ENTRY 


57 


Crediting  a  customer  with  the  settlement  of  his  debt 
to  the  proprietor,  amounts  to  the  same  thing  as  debiting 
the  proprietor  with  the  asset  with  which  he  has  parted, 
i.e.,  a  claim  against  a  person,  and  crediting  him  with  the 
new  asset  which  has  come  in,  whether  this  new  asset  be  cash 
or  its  equivalent. 

Crediting  a  creditor  with  the  value  of  the  goods  sold 
by  him  on  credit  to  the  proprietor,  is  equivalent  to  debit- 
ing the  proprietor  with  the  new  liability  which  he  has  in- 
curred, and  crediting  him  with  the  new  asset  which  he  has 
obtained  in  return. 

Debiting  a  creditor  with  the  settlement  of  his  claim 
amounts  to  crediting  the  proprietor  with  the  liability 
which  he  has  liquidated,  and  debiting  him  with  the 
amount  of  cash,  or  its  equivalent,  with  which  he  has  parted 
as  a  result  of  the  transaction. 

Crediting  the  proprietor  at  the  end  of  the  period  with 
the  net'  increase  of  the  values  invested  by  him  at  the  be- 
ginning, is  equivalent  to  crediting  him,  in  detail,  with  all 
the  increases  of  assets  plus  the  decreases  of  liabilities,  and 
debiting  him  with  all  the  decreases  of  assets  plus  the  in- 
creases of  liabilities.  This,  in  turn,  is  identical  to  crediting 
him  in  detail  during  the  accounting  period,  with  all  the 
values  which  have  come  into  the  business,  and  debiting 
him  with  all  the  values  which  have  gone  out  of  the  busi- 
ness. By  "values"  as  used  here,  is  meant  not  only  tangible 
values,  but,  as  well,  increases  or  decreases  of  the  proprie- 
tor's equity  in  his  assets.  Since  the  debts  of  the  proprie- 
tor constitute  liens  against  his  assets,  it  follows  that  when 
he  liquidates  a  liability  there  has  gone  out  of  the  business 
cash,  or  its  equivalent;  but  there  has  come  into  the  busi- 
ness a  new  value,  that  is  to  say,  an  increase  of  equity  in 
the  form  of  the  decrease  of  a  debt,  which  is  to  his  benefit 
and  with  which  he  is  to  be  credited. 


eg        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

Equations  of  Single-Entry  System 

The  system  of  single-entry  bookkeeping  is  reducible 
to  the  following  equations : 

1.  Initial  assets  less  initial  liabilities  =  initial  net 

worth. 

2.  Increases  of  assets  plus  decreases  of  liabilities  = 

factors  in  favor  of  the  proprietor. 

3.  Decreases  of  assets  plus  increases  of  liabilities  = 

factors  against  the  proprietor. 

4.  Factors  for  the  period  in  favor  of  the  proprietor 

less  factors  for  the  period  against  the  proprietor 
=  net  increase  of  net  worth. 

5.  Assets  at  end  of  the  period  less  liabilities  at  end 

of  the  period  =  net  worth  at  the  end  of  the 
period. 

6.  Net  worth  at  the  end  of  the  period  less  net  worth 

at  beginning  of  the  period  =  net  increase  of  net 
worth  during  the  period. 

In  connection  with  equation  6,  it  must  be  said  that  the 
net  increase  of  the  net  worth  does  not  necessarily  indicate 
the  extent  of  the  profits  obtained.  If,  for  instance,  new 
capital  contributions  or  withdrawals  of  capital  have  taken 
place  during  the  period,  the  profits  would  be : 
In  the  first  instance : 

Net   increase   of   net   worth   less   contributions   of 
capital. 
In  the  second  instance : 

Net  increase  of  capital  plus  withdrawals  of  capital. 

Sources  of  Gains  and  Losses  Not  Shown 

It  would  appear  from  the  foregoing,  that  while  the 
single-entry  system  makes  it  possible  to  obtain  the 
amount  of  profits  (or  losses)  of  a  given  period,  and  to  sup- 


SINGLE    ENTRY 


59 


port  it,  on  the  one  hand,  by  the  detail  of  the  increases  of 
assets  added  to  the  decrease  of  liabilities,  and,  on  the 
other  hand,  by  the  detail  of  the  decreases  of  assets  added 
to  the  increases  of  liabilities,  the  causes  which  have 
brought  about  the  increases  and  decreases  are  not  obtain- 
able. That  this  is  the  opinion  of  a  great  many  writers  of 
accounting,  could  be  shown  by  a  multitude  of  quotations. 
It  has  been  said  that  single  entry  "fails  to  fulfil  the  object 
of  bookkeeping,  in  that  it  does  not  exhibit  the  true  finan- 
cial condition  of  the  business,  and  is  incapable  of  proof  of 
accuracy."  Lisle  says  in  "Accounting  in  Theory  and 
Practice,"  that  "no  detailed  Profit  and  Loss  account 
can  as  a  rule  be  prepared,  and  there  is  no  satisfactory 
check  on  the  accuracy  of  the  results,  as  is  provided  by  the 
balancing  of  the  books  which  have  been  kept  by  double 
entry."  Greendlinger  asserts  that  "many  evils  continue 
to  exist  although  we  know  them  to  be  such.  Single  entry 
is  certainly  an  evil  in  modern  accountancy,  and  account- 
ants greatly  discourage  its  use — the  disadvantages  of  the 
method  are  not  lessened  if  it  is  used  by  a  small  rather  than 
by  a  large  concern," 

Notwithstanding  the  above  quotations,  it  would  be 
wrong  to  suppose  that  the  single-entry  system  is  of  slight 
use.  The  fact  that  it  was  in  vogue  in  Italy,  the  birthplace 
of  double  entry,  up  to  the  year  1869  when  a  law  made  the 
adoption  of  the  latter  system  compulsory  in  so  far  at  least 
as  the  accounts  of  the  Italian  government  were  concerned, 
seems  to  indicate  that  it  is  more  serviceable  than  it  is 
generally  supposed. 

Proprietor's  Account 

It  has  been  said  that,  if  properly  kept,  the  proprietor's 
account  appearing  in  a  single-entry  ledger  can  be  made  to 
reflect,  during  the  accounting  period,  all  the  facts  which 
it  is  necessary  to  know  at  the  end.    It  may  be  of  interest 


6o        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

and  of  some  value  to  take  simple,  familiar  factors,  and  see 
how  they  can  be  handled  in  order  to  prove  this  contention. 
We  will  consider: 

1.  Purchases 

2.  Sales 

3.  Cash  Receipts 

4.  Cash  Disbursements 

5.  Promissory  Notes 

as  to  the  effect  of  the  transactions  involved,  upon  both 
the  proprietor's  account,  and  the  personal  accounts  of 
creditors  and  customers. 

1.  Purchases 

a.  Credited  to  the  creditors  to   record  their 

claim  against  the  proprietor. 

b.  Credited  to  the  proprietor  as  representing 

an  asset  acquired  during  the  period. 

2.  Charge  Sales 

a.  Debited  to  customers  at  sales  price  to  re- 

cord the  proprietor's  claim  against  per- 
sons for  merchandise. 

b.  Debited  to  the  proprietor  at  cost  as  repre- 

senting the  value  of  the  asset  which  has 
been  parted  with;  or  debited  to  the  pro- 
prietor at  sales  price,  the  profit  realized 
on  the  sale  being  further  credited  to  him 
as  representing  the  excess  value  of  the 
assets  which  he  has  received  through  the 
exchange  over  the  value  of  the  assets 
with  which  he  has  parted. 

3.  Cash  Receipts  (Cash  Sales) 

a.  Cash  received  from  customers,  credited  to 
them  to  show  the  reduction  of  the  pro- 
prietor's claim,  and  credited  also  to  the 
proprietor  as  representing  an  asset  which 
has  come  into  the  business. 


SINGLE    ENTRY  6l 

b.  Cash    received    on    account    of  cash    sales, 

credited  to  the  proprietor  as  represent- 
ing the  proceeds  of  an  asset  which  has 
gone  out;  at  the  same  time  merchandise 
sold,  debited  to  the  proprietor  at  cost  as 
representing  the  value  of  the  asset  which 
has  been  sold. 

c.  Cash   received   in   the   form   of  credits  by 

banks  for  interest,  credited  to  the  pro- 
prietor as  representing  the  gain  made  on 
investments  of  cash,  etc. 

4.  Cash  Disbursements 

a.  Cash  paid  to  creditors,  debited  to  them  to 

show  the  reduction  of  their  claims 
against  the  proprietor,  and  debited  also 
to  the  proprietor  as  representing  an 
asset  which  has  gone  out  of  the  business. 

b.  Cash  paid  for  expenses,  debited  to  the  pro- 

prietor as  representing  the  cost  to  him  of 
conducting  his  business,  etc. 

5.  Promissory  Notes 

a.  Received;  credited  to  the  customers  who 

give  them,  and  credited  also  to  the  pro- 
prietor as  representing  a  new  asset  which 
has  come  in. 

b.  Collected;  treated  both  as  a  debit  and  as  a 

credit  to  the  proprietor,  to  record  the 
exchange  of  one  asset  for  another. 

c.  Issued   by   the  proprietor;   debited   to   the 

creditor  to  whom  issued,  and  also  to  pro- 
prietor as  representing  a  new  liability. 

d.  Paid;   treated   both   as   a   debit   and   as   a 

credit  to  the  proprietor,  to  record  the 
loss  of  cash  and,  at  the  same  time,  the  de- 
crease of  a  liability. 


62        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

Closing  the  Accounts 

The  method  of  handling  the  accounts  at  the  close  of 
the  period  is  as  follows: 

1.  Customers.  The  balance  of  their  accounts,  less 
the  balance  at  the  beginning  of  the  period,  if  any,  credited 
to  the  proprietor  at  the  close  of  the  period;  claims  against 
customers  being  the  only  asset  not  directly  credited  to 
him  during  the  period. 

2.  Creditors.  The  balance  of  their  accounts,  less  the 
balance  at  the  beginning  of  the  period,  if  any,  debited  to 
the  proprietor  at  the  close  of  the  period;  creditors'  claims 
being  the  only  liability  not  directly  debited  to  him  during 
the  period. 

3.  Closing  Inventory  of  Merchandise.  Ignored  in 
so  far  as  the  proprietor's  account  is  concerned,  since  it  is 
already  included  therein.  This  is  obvious,  for  if  the  pro- 
prietor's account  as  it  stands  has  been  credited  with  initial 
inventory,  plus  purchases,  and  debited  with  sales  at  cost 
(or  debited  with  sales  at  sales  price,  and  credited  with 
profits  on  sales  at  time  of  sales),  the  excess  credits  over 
debits  on  account  of  merchandise  represent  the  closing 
inventory. 

4.  Proprietor's  Account.  Closed  at  the  end  of  the 
period  by  inserting  on  the  debit  side  "Balance"  represent- 
ing the  net  investment  which  must  be  supported  by  a 
statement  of  assets  and  liabilities;  and  reopened  for  the 
new  period  by  crediting  the  proprietor  with  all  his  assets, 
and  debiting  him  with  all  his  liabilities  as  shown  by  the  in- 
ventory of  all  the  values,  positive  and  negative. 

Practicability  of  System 

That  such  a  system  can  be  used  is  evidenced  by  the 
fact  that  the  principle  of  the  proprietor's  account  as  given 
above  forms  the  basis  of  the  quadruple-entry  systems 
known  as  Logismography  and  Statmography,  evolved  in 


SINGLE    ENTRY 


63 


Italy  only  a  few  years  ago,  one  of  the  objects  of  which  is 
to  reflect  the  net  worth  of  the  proprietorship  at  all  times 
without  having  to  take  inventories.  That  the  principles 
underlying  the  above  treatment  of  the  proprietor's  ac- 
count are  correct,  is  shown  by  the  following  examples: 


John  Harrison,  Proprietor — Single-Entry  Ledger 
Classified  Transactions 


1912 
Jan.     I 

Liabilities : 
Mortgage 
Payable  . . . 
Notes  P  a  y  - 

$5,000.00 

1912 
Jan.     I 

Assets     In- 
vested : 

Cash  

Merchandise. 

$7,500.00 
1,000.00 

able 

Creditors  ... 
Net  Investment 

3,000.00 

2,000.00 

i5,ooaoo 

Land    and 
Building.. . 

Horse,  Wag- 
on       and 
Harness  . . 

Furniture  and 

13,000.00 
2,000.00 

I 
30 

Total 

Assets     Parted 
with    During 
the  Period : 
Merchandise, 

Jan. 
to 
June 

I 
30 

Fixtures  .. 
Total 

Net  Investment 

Net  Assets  Ac- 
quired    Dur- 
i  n  g       the 

1,500.00 

$25,000.00 

$25,000.00 

Jan. 

to 
June 

$15,000.00 

at  cost 

Cash: 

Paid  to  cred- 
itors     

Paid   at   ma- 

$9,000.00 
9,500.00 

Period : 
Merchandise 

purchased.. 
Cash  received 

from  cus- 

$12,000.00 

t  u  r  i  t  y  of 
notes    pay- 

tomers  . . . 
Cash  Interest 

7,000.00 
50.00 

able  

Paid  for  cur- 
rent needs. 

3,000.00 
300.00 

Promissory 
Notes     re- 
ceived from 

Total 

customers.. 

Customers' 

Accounts*.. . 

Total 

So.oo 
2,950.00 

$21,800.00 

$22,050.00 

*  If  there  had  been  customers'  accounts  at  the  beginning  of  the  period,  only 
the  increases  would  be  credited. 


64 


THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

John  Harrison,  Proprietor — Single-Entry  Ledger 
Classified  Transactions — Continued 


Liabilities 

Reduction  of 

Incurred 

Liabilities : 

During  the 

Notes   Pay- 

Period: 

able  paid..     $3,000.00 

Promissory 

Notes  Pay- 

able, issued 

to  creditors 

$1,100.00 

Increase     o  f 

creditors' 

accounts,  as 

shown  by 

the  ledger. 

1,400.00 

Total 

$2,500.00 

Net  Investment  $15,750.00 

Total 

^40,050.00 

Total $40,050.00 

If  we  were  to  express  the  factors  found  in  the  account  of 
the  proprietor,  we  would  obtain : 


Merchandise  Transactions 

Debits 

Initial  Inventory $  1,000.00 

Purchases 12,000.00 

Total  debits $13,000.00 

Credits 

Cost  of  goods  sold  (Le.,  purchase  cost) 9,000.00 

Closing  Inventory  (difference  between  cost  of  goods 
purchased  and  cost  of  the  part  of  these  goods  which 
**«  «'1<»)  $4,000.00 


SINGLE   ENTRY  65 

Transactions  with  Customers 

Debits 

Initial  Balance (none)  $ 

Sales : 

Settled  for  in  cash 7,000.00 

Settled  for  by  notes 50.00 

Balance  carried  on  open  accounts 2,950.00 


Total  debits $10,000.00 

Credits 

Cash  Received $7,000.00 

Promissory  Notes 50.00 


Total  credits 7,050.00 


Balance  due  by  customers $2,950.00 

Transactions  with  Creditors 

Credits 

Initial  Balance $2,000.00 

Purchases  12,000.00 


Total  credits $14,000.00 

Debits 

Cash  paid  to  them $9,500.00 

Promissory  Notes 1,100.00 


Total  debits 10,600.00 


Balance  due  to  creditors $3,400.00 


Transactions  in  Promissory  Notes  Receivable 

Received  from  customers,  not  matured,  not  discounted. .  $50.00 


Transactions  IN  Promissory  Notes  Payable 

Credits 

Initial  Balance $3,000.00 

Given   to    creditors    in    settlement   of    their 
accounts 1,100.00 

Total  credits $4,100.00 


56        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

Transactions  in  Promissory  Notes  Payable — Continued 

Debits 

Paid  in  cash  at  maturity 3,000.00 

Balance  outstanding $1,100.00 

Cash  Transactions 
Debits 

Initial  Investment $7,500.00 

Received  from  customers 7,000.00 

Credited  by  bank  for  interest 50.00 

Total  debits $14,550.00 

Credits 

Paid  to  creditors $9,500.00 

Paid  at  maturity  of  notes  payable 3,000.00 

Paid  for  current  expenses 300.00 

Total  credits 12,800.00 

Balance  on  hand $1,750.00 

Profit  and  Loss 

(For  the  period) 
Profits 

Gross  profit  on  merchandise  sales $io,ooaoo 

Less  cost  of  sales 9,000.00 

$1,000.00 
Interest  on  bank  balances 50.00 

Total  profits $1,050.00 

Expenses  300.00 

Net  profit $750.00 

From  the  foregoing  information  we  can  build  up, 
without  difficulty,  the  following  statement  which  has  been 
said  to  be  the  only  form  of  financial  statement  possible 
under  single  entry: 


SINGLE    ENTRY 


^ 


Statement  of  Assets  and  Liabiuties  of  John  Harri- 
son, AT  January  i  and  June  30,  1912,  as  per  his 
Single-Entry  Ledger,  Books,  and  Records 

Assets 

January  i  June  30      Increases   Decreases 

Cash  $7,500.00  $1,750.00                     $5,750.00 

Merchandise    1,000.00  4,000.00    $3,000.00 

Land  and  Building 13,000.00  13,000.00 

Horse,   Wagon   and   Har- 
ness    2,000.00  2,000.00 

Furniture  and  Fixtures. , .  1,500.00  1,500.00 

Sundry  Customers 2,950.00      2,950.00 

Notes  Receivable 50.00  50.00 

Total $25,000.00    $25,250.00    $6,000.00    $5,750.00 


Liahilities 

January  i  June  30    Decreases   Increases 

Mortgages  Payable $  5,000.00  $  5,000.00 

Notes   Payable 3,000.00        1,100.00    $1,900.00 

Creditors'  Accounts 2,000.00       3,400.00  $1,400.00 

Total $10,000.00    $  9,500.00    $1,900.00    $1,400.00 

John  Harrison,  Capital 15,000.00      15,000.00 

Total $2S,ooaoo    $24,500.00 

Total   Increases  and   De- 
creases    $7,900.00    $7,150.00 

Net  Increase  of  Investment  $  750.00 

From  the  foregoing,  it  will  be  seen  that  sweeping  de- 
nunciations of  the  single-entry  system  are  not  fully  justified. 

We  need  not,  however,  go  so  far  in  order  to  clear 
single  entry  of  the  odium  cast  upon  it  by  unsympathetic 
writers  who  have  sentenced  it  on  the  merits  of  its  ledger. 
The  ledger  is  not  the  only  book  of  record  which  can  be 


68         THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

kept  under  the  system;  and  if  double  entry  has  found  it 
necessary  to  divide  its  journal  into  its  components,  i.e., 
cash,  purchases,  sales,  etc.,  as  we  will  see  later  when  treat- 
ing of  the  evolution  of  the  books  of  account,  there  is  no 
reason  why  single  entry  could  not  do  the  same  thing 
and  be  made  highly  analytical.  Admittedly,  the  single- 
entry  ledger  is  of  no  great  help  so  far  as  statements  are 
concerned;  but  few  accountants  would  be  willing  to  admit 
that  they  could  not  prepare  financial  statements  from 
books  of  original  entry.  A  merchandise  stock  book,  a 
cash  book,  a  sales  book,  and  a  purchase  book  are  not 
necessary  to  the  proper  working  of  single  entry,  but  they 
can  be  kept  without  interfering  with  the  principles  and 
purpose  of  the  system. 

It  cannot  be  denied  that  no  trial  balance  of  a  single- 
entry  ledger  can  be  taken  if  we  give  to  the  word  "trial 
balance"  the  sense  that  it  has  only  when  referring  to  the 
general  ledger  kept  by  double  entry.  It  must  be  admitted 
that  errors  which  creep  into  single-entry  records  are  not 
readily  detected,  for  there  is  no  equilibrium  to  be  main- 
tained; that  without  a  properly  kept  proprietor's  account, 
the  ledger  does  not  show  the  causes  for  the  increases  and 
decreases  of  assets  and  liabilities,  and  that,  therefore, 
there  can  be  no  profit  and  loss  account  in  the  ledger;  that 
the  assets  and  liabilities  can  be  obtained  at  the  end  of  the 
period  only  by  inventory,  or  by  adding  to,  or  deducting 
from,  the  assets  and  liabilities  as  at  the  beginning  of  the 
period,  the  transactions  of  the  period  shown  by  the  sun- 
dry records  and  memoranda.  But  when  all  that  is  ad- 
mitted, it  remains  true  that  single  entry  is  capable  of  giv- 
ing excellent  results. 


CHAPTER  VI 
ACCOUNTING  SYSTEMS— DOUBLE  ENTRY 

The  Purpose  of  Double  Entry 

We  have  seen  that  the  purpose  of  single  entry  is  to 
record,  in  the  ledger,  transactions  with  persons  only.  It 
does  not  concern  itself  with  the  effect  of  such  transactions 
upon  invested  values,  since  this  will  be  shown  by  an  in- 
ventory at  the  end  of  the  period;  nor  is  it  interested  in 
individual  results  and  causes,  since  the  only  thing  of  im- 
portance is  the  net  increase  or  decrease  of  net  worth.  In 
contradistinction,  the  purpose  of  double  entry  is  to  record 
in  the  ledger  all  financial  transactions,  of  whatever  nature 
they  may  be,  and  to  take  into  consideration  the  financial 
fact,  its  cause,  its  effect,  and  its  result. 

Principles  of  Double  Entry 

The  system  is  based  on  the  doctrine  of  equilibrium, 
that  is  to  say  that  tendency  supposed  to  be  inherent  in  the 
nature  of  things,  which  makes  them  seek  to  maintain  a 
harmonious  balance  among  their  sundry  elements.  Busi- 
ness is  amenable  to  the  doctrine  of  equilibrium.  To  show 
that  it  has  acquired  a  harmonious  balance  among  its  ele- 
ments, and  maintained  it,  the  recording  system  known  as 
double  entry  must  be  employed,  of  which  the  following  are 
the  underlying  principles : 

I.  Initial  equilibrium  must  be  established  by  bal- 
ancing what  the  proprietor  owns,  that  is  to  say 
his  assets,  with: 

69 


70   THEORY  AND  TECHNIQUE  OF  ACCOUNTS 

a.  What  he  owes,  i.e.,  his  liabilities 

b.  His  equity  in  his  assets,  i.e.,  his  net  invest- 

ment, or  net  worth 

2.  The  initial  equilibrium  once  established,  is  dis- 

turbed whenever  a  financial  transaction  occurs. 

3.  Every  financial  transaction  may  be  subdivided 

into  two  or  three  parts: 

a.  The  effect 

b.  The  counterpart 

c.  The  result,  if  any 

4.  Every  financial  transaction  has  for  effect  the  in- 

come or  the  outgo  of  financial  values. 

5.  Incoming  or  outgoing  values  are: 

a.  Counteracted    by    outgoing    or    incoming 

values  of  a  weight : 

( 1 )  Greater  than  their  own ;  in  this  case, 
there  has  been  an  exchange  of  values 
resulting  in  a  gain  or  a  loss. 

(2)  Smaller  than  their  own;  in  this  case 
there  has  been  an  exchange  of  values 
resulting  in  a  loss  or  a  gain. 

(3)  Equal  to  their  own ;  in  this  case  there 
has  been  an  exchange  of  values  with  no 
result. 

b.  Counteracted   by   the   receipt   or   the   per- 

formance of  services,  the  cost  or  the  value 
of  which  they  measure. 

c.  Not  counteracted  by  either  income  or  outgo, 

or  by  service  received  or  rendered,  and  as 
a  consequence,  resulting  in  a  profit  or  a 
loss. 

A  Balancing  System 

Thus,  the  system  of  double-entry  bookkeeping  may  be 
compared  to  a  balancing  scale  provided  with  two  weigh- 


DOUBLE  ENTRY 


71 


ing  dishes,  one  for  the  positive  (debit)  facts,  the  other 
for  negative  (credit)  facts.  As,  of  necessity,  the  business 
cannot  be  carried  on  unless  the  positive  facts  (debits)  ex- 
ceed the  negative  facts  (credits),  it  follows  that  in  order 
to  establish  equilibrium  between  the  two  sides  of  the 
scale,  an  additional  weight  must  be  added  on  the  right 
side  to  represent  the  equity  of  the  proprietor  in  the  posi- 
tive facts. 

Positive  facts  assert  that  the  values  which  they  repre- 
sent are  owned  by  the  proprietor,  or  that  they  have  been 
expended  or  lost  by  him  in  the  course  of  operations. 
Negative  facts  deny  the  ownership  asserted  by  positive 
facts;  or  they  show  gains  offsetting  losses  or  benefits  off- 
setting the  disappearance  of  positive  values. 

The  weighing  of  transactions,  which  is  necessary  in 
order  that  their  effect,  their  counterpart,  and  their  result 
may  be  ascertained  and  recorded  in  such  a  way  as  to  re- 
establish equilibrium,  is  performed  through  the  help  of 
charges  and  discharges,  that  is  to  say,  debits  and  credits. 
The  book  in  which  the  debits  and  the  credits  are  re- 
corded is  the  journal. 

Rules  for  Journalizing 

The  rules  for  the  recording  of  debits  and  credits,  that 
is  to  say,  the  rules  for  journalizing,  are  as  follows: 

I.     At  the  incipiency  of  the  business: 

a.  The  business  is  to  be  debited  in  detail  with  what  it 
has  received  from  the  proprietor, 

b.  The  business,  being  debited  with  what  it  has  re- 
ceived, must,  of  necessity,  be  credited  in  detail  with  what 
it  will  be  called  upon  to  spend  in  order  that  it  may  meet 
the  obligations  incurred  by  the  proprietor  as  a  result  of 
the  acquisition  of  the  wealth  which  he  has  invested. 

c.  The  business,  being  debited  in  accordance  with  the 


72         THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

above  rules  with  all  the  values  invested  by  the  proprietor, 
and  credited  with  what  it  will  have  to  spend  in  order  to 
retain  them,  stands,  in  fact,  debited  with  the  proprietor's 
net  wealth;  hence,  the  proprietor  must  be  credited  with 
his  net  investment,  in  order  that  equilibrium  may  be  had. 

2.  During  the  course  of  the  accounting  period : 

a.  The  business  being  charged  with  such  values  as 
have  been  intrusted  to  it,  is,  of  course,  debited  with  all 
increases  in  the  said  values,  through  the  medium  of 
proper  debits  to  the  particular  values  which  have  been 
benefited  by  the  increases.  In  order  that  the  equilibrium 
thus  disturbed  may  be  reestablished,  such  debts  as  have 
been  incurred,  owing  to  the  acquisition  of  the  increases  in 
wealth,  must  be  recorded  through  the  medium  of  proper 
credits  to  the  individual  creditors. 

b.  The  business  being  debited  in  detail  with  all  values, 
any  change  occurring  to  the  benefit  of  any  given  value, 
and  to  the  detriment  of  another,  or  others,  must  be  re- 
corded by  debiting  the  beneficiary,  and  crediting  the 
loser,  or  losers. 

c.  Any  reduction  in  the  amount  of  the  values,  due  to 
the  liquidation  of  the  proprietor's  debts,  must  be  shown 
by  a  debit  to  the  beneficiary  of  the  settlement,  and  a 
credit  to  the  value  which  had  been  decreased. 

d.  Any  loss  sustained  is  to  be  credited  to  the  value 
which  has  been  partially  or  totally  lost,  and  charged  to  an 
account  which  will  record,  during  the  fiscal  period,  all  the 
losses  incurred. 

e.  Any  gain  is  to  be  debited  to  the  value  which  has 
been  increased  thereby,  and  credited  to  an  account  which 
will  record  all  the  gains  made  during  the  period. 

t 

3.  At  the  end  of  the  fiscal  period : 

The  net  amounts  of  the  gains  made,  as  represented  by 


DOUBLE    ENTRY  73 

the  summary  account  which  shows  all  losses  and  gains, 
is  now  credited  to  the  proprietor.  Conversely,  if  the  pre- 
ponderance is  on  the  side  of  losses,  the  proprietor  must 
be  debited.  The  equilibrium  which  has  been  disturbed  by 
the  credit  or  the  debit  to  the  proprietor,  is  reestablished 
by  debiting  or  crediting  the  summary  account,  thereby 
closing  it. 

Profit  and  Loss  Account  and  Nominal  Accounts 

Modern  bookkeeping  has  found  the  Profit  and  Loss 
account,  which  is  the  name  given  to  the  summary  account 
mentioned  above,  awkward  and  inconvenient.  The  vol- 
ume of  the  transactions  which  occur  in  the  conduct  of 
present-day  business  is  so  considerable,  that  causes  and 
results,  if  treated  in  one  account,  necessitate  extensive 
analysis  in  order  that  proper  information  may  be  obtained. 
It  has  been  found  advantageous  to  create  during  the  fiscal 
period  a  series  of  accounts  which  are  charged  with  all 
losses  due  to  the  parting  with  of  values  which  have  not  been 
counteracted  by  the  incoming  of  values  possessing  finan- 
cial weight.  In  other  words,  all  expenses  paid  by  the 
business  are  recorded  in  special  accounts  bearing  a  title 
indicative  of  their  contents.  At  the  end  of  the  fiscal 
period,  all  these  accounts,  having  served  their  purpose, 
w^hich  was  to  gather,  analytically,  facts  of  a  similar  nature, 
are  closed  into  the  Profit  and  Loss  account  by  means  of  a 
credit  to  the  individual  accounts,  and  a  debit  to  the 
Profit  and  Loss  account  for  the  aggregate  amount.  The 
same  method  is  used  for  such  gains  as  are  indirectly  con- 
nected with  the  operations  of  the  period  (such  as  interest 
on  bank  balances,  cash  discounts  on  purchases,  etc.,  etc.). 
The  Profit  and  Loss  account  is  still  directly  debited  and 
credited,  during  the  fiscal  period,  w-ith  all  such  losses  and 
gains  as  are  not  the  result  of  the  operations  of  the  period 
(for  instance,  the  loss  of  a  customer's  account  or  the  loss 


74         THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

of  property  through  fire  or  other  causes  over  which  the; 
business  has  no  control),  and  with  gross  profits  on  mer- 
chandise. This  last  entry  is  made  directly  in  the  Profit 
and  Loss  account  because  the  result  which  it  shows  is 
known  only  at  the  end  of  the  period,  after  the  application 
of  the  inventory. 

Rules  for  Double  Entry 

Repeated  attempts  have  been  made  to  reduce  the 
principles  of  double-entry  bookkeeping  to  simple  rules 
easily  memorized  and  supposed  to  cover  all  possible  business 
transactions ;  for  instance : 

1.  "Debit    what    comes   into    the   business;   credit 

what  goes  out  of  the  business." 

2.  "Whoever  or  whatever  owes  the  business  or  firm 

is  a  debtor,  and  must  be  debited;  whoever  or 
whatever  the  business  or  firm  owes  is  a  cred- 
itor, and  must  be  credited." 

3.  "The  fundamental  principle  of  double  entry  is 

that  there  must  be  a  credit  for  every  debit." 

Irrespective  of  the  fact  that  such  formulas  are  apt  to 
lead  the  reader  towards  the  fatal  belief  that  the  mastery 
of  double-entry  bookkeeping  is  merely  a  matter  of  mem- 
orizing a  simple  rule,  they  are  more  than  useless  to  the 
student  of  accounting.  He  does  not  understand  them, 
and,  consequently,  is  unable  to  apply  them.  Taking  as 
an  illustration  rule  i,  which  is  probably  the  least  mislead- 
ing of  the  three,  let  us  assume  that  $50  in  cash  has  been 
received  by  the  business  in  consideration  of  the  indorse^ 
ment  by  the  proprietor  of  a  promissory  note  executed  by 
a  person  with  whom  he  has  had  business  dealings.  How 
would  the  student  apply  the  rule?  He  would,  naturally, 
debit  cash,  because  it  is  plain  that  cash  has  come  into  the 
business;  but  what  would  he  credit?     That  which  has 


DOUBLE  ENTRY 


75 


really  gone  out  of  the  business,  admitting  that  the  stu- 
dent is  sufficiently  advanced  to  reason  that  far,  is  precisely 
the  one  thing  which  he  cannot  credit,  since  it  is  a  possible 
loss  of  equity  in  the  assets  in  the  form  of  a  Hability  con- 
tingent upon  the  dishonor  of  the  note  at  maturity.  Would 
he  see  that  the  credit  is  to  be  given  to  the  cause  which 
brought  about  an  increase  in  the  asset  "Cash"  without  neces- 
sitating the  outgo  of  an  equivalent  amount  of  another 
financial  value? 

Basic  Differences  Between  Single  and  Double  Entry 

The  great  advantage  which  double  entry  possesses 
over  single  entry,  Hes  in  the  difference  between  the  duties 
of  the  basic  books  used  under  both  methods,  i.e.,  the  journal, 
and  the  ledger. 

The  single-entry  journal  confines  itself  to  the  daily  re- 
cording of  facts,  earmarking  the  transactions  with  persons 
in  such  a  manner  that  they  can  be  gathered  in  another 
book,  the  ledger,  where  their  extent  and  their  status  may 
be  readily  determined.  The  single-entry  ledger  does  not 
concern  itself  with  the  other  factors  of  the  proprietor's 
wealth.  It  cannot  be  balanced,  it  cannot  be  closed,  and 
as  it  usually  does  not  take  advantage  of  the  analytical 
power  of  other  books,  it  is  practically  of  no  help  in  the 
preparation  of  financial  statements. 

The  double-entry  journal  is  not  only  a  recorder,  but 
an  investigator,  an  analytical  force  always  at  work, 
which,  as  between  debits  and  credits,  weighs  and  classifies 
everything  which  is  presented  to  it.  If  the  occasion  arises, 
the  journal  gives  a  name  to,  and  appraises,  the  weights 
necessary  to  reestablish  the  equilibrium  between  the  two 
main  elements  of  a  transaction.  Having  thus  classified 
the  facts,  the  journal  passes  them  over  to  the  ledger, 
which  groups  them  with  a  view  to  the  preparation  of 


76        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

financial  statements.  Both  the  journal  and  the  ledger  can 
be  balanced  by  themselves,  thereby  acting  as  a  check  one 
upon  the  other. 

Passing  from  Single  Entry  to  Double  Entry 

Passing  from  single  entry  to  double  entry  should  pre- 
sent no  difficulty  whatever  to  one  who  is  famiUar  with 
the  principles  underlying  these  two  systems  of  accounting. 
If  the  books  used  for  single  entry  are  to  be  retained 
under  the  new  system,  two  journal  entries  are  required 
in  case  the  profit  of  the  period  has  not  been  credited  to 
the  proprietor's  capital  account.  In  the  contrary  case, 
one  entry  will  be  sufficient.  If  new  books  are  to  be 
opened,  one  entry  will  accomplish  the  change.  To  illus- 
trate, we  will  suppose  that  Charles  Adams,  whose  books 
have  been  kept  by  single  entry,  desires  to  adopt  the 
double-entry  system,  and  assume: 

i-a.     That  the  present  books  are  to  be  retained. 
b.     That  Charles  Adams'  capital  account  has 

not  been  credited  with  the  profits  of  the 

period. 
2-a.     That  new  books  are  to  be  opened. 

The  procedure  under  the  first  assumption  would  be: 

1.  Analyze    the    single-entry    records,    and    obtain 

therefrom  all  possible  information  leading  to 
the  establishment  of  a  statement  of  assets  and 
liabilities  similar  to  the  model  given  in  Chapter 
V;  supplement  the  information  thus  obtained 
by  any  further  step  necessary  to  ascertain  the 
exact  status  of  the  business  at  the  date  of  the 
change  of  systems. 

2.  Journalize  the  facts  thus  ascertained,  in  such  a 

manner  as  to  show : 


DOUBLE    ENTRY 


17 


a.  In  the  first  entry: 

(i)  All  the  assets  shown  by  the  statement  of 
assets  and  liabilities,  whether  already  on 
the  ledger,  or  not. 

(2)  All  the  liabilities,  whether  already  on  the 

ledger,  or  not. 

(3)  The  proprietor's  net  investment  as  it  stood 

at  the  beginning  of  the  period. 

(4)  The  profit  of  the  period,  representing  the 

amount  by  which  the  assets  at  the  end 
of  the  period  exceed  the  liabilities  at  the 
end  of  the  period,  plus  the  proprietor's 
net  investment  at  the  beginning  of  the 
period. 

(5)  Earmark  by  means  of  some  appropriate  sign, 

the  assets  and  liabilities  which  are  already 
in  the  ledger,  and  in  the  explanation  of  the 
entry  refer  to  the  fact  that  these  items  re- 
quire no  posting. 

b.  In  the  second  entry: 

(i)  The  closing  of  the  profit  and  loss  balances 
to  the  debit  or  to  the  credit  of  the 
proprietor. 

If  the  net  profit  of  the  period  has  been  credited  to  the 
proprietor  before  the  passing  from  single  to  double  entry, 
only  one  journal  entry  is  required.  In  this  case,  the  excess 
of  assets  over  liabilities  represents  exactly  the  capital  in- 
vested, as  shown  by  the  single-entry  ledger. 


78        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

Example  based  on  the  first  assumption: 

Journal  of  Charles  Adams 

Ledger 

Folio  Dr.  Cr. 

I  Land  and  Buildings $6,000.00 

3  Furniture  and  Fixtures  as  per  appraisal. .         9i5-00 

5  Horse,  Wagon  and  Harness 750-00 

6  Merchandise  Inventory  (as  per  inventory 

book)    3,435.00 

7  Cash  in  bank  and  in  office  (as  per  bank 

certificate  and  physical  count) 3,470.oo 

10      Notes  Receivable 50.00 

13-30      Sundry  Customers  (as  per  list) 995-00* 

60         To  First  Bond  and  Mortgage  Payable.  $2,500.00 

62  Notes  Payable 2,000.00 

80-90  Sundry  Creditors  (as  per  list)....  1,800.00* 

95  Profit  and  Loss  (as  per  analysis) .  1,315.00 

100  Charles  Adams,  Capital 8,000.00* 

To  change  the  books  of  Charles  Adams 
from  single  entry  to  double  entry.  The 
facts  reflected  above  have  been  obtained 
from  a  statement  of  assets  and  liabili- 
ties, showing  increases,  decreases,  and 
net  capital  increase,  prepared  as  of  De- 
cember 31,  191 1,  and  now  on  file. 

95      Profit  and  Loss $1,315.00 

100         To  Charles  Adams,  Capital $1,315.00 

To  transfer  to  the  capital  account  of  the 
proprietor  the  net  profit  of  the  year 
ended  December  31,  191 1,  as  shown  by 
the  analysis  of  his  books,  records,  and 
accounts,  made  in  anticipation  of  the 
change  from  single  entry  to  double 
entry. 

As  to  the  facts  which  are  already  in  the  ledger  and 
require  no  posting,  they  depend  entirely  upon  the  condi- 
tion of  the  single-entry  books.  The  example  given  above 
presupposes  that  the  books  of  Charles  Adams  complied 
with  the  rules  of  single  entry,  and  carried  only  accounts 
with  persons. 

•These  hems  are  already  on  tlie  books,  and  require  no  posting. 


DOUBLE    ENTRY 


79 


k 


The  procedure  under  the  second  assumption  would  be 
similar  in  every  respect,  the  only  difference  being  in  the 
form  of  the  journal  entry,  which  might  be  as  follows: 

Journal  of  Charles  Adams 
Ledger 

Folio  Dr.  Cr. 

Pro  Forma 
Charles  Adams,  sole  trader,  having  aban- 
doned the  single-entry  system  by  which 
his  books  were  kept  up  to  this  date, 
new  books  are  to  be  opened.  The  fol- 
lowing entry  is  made  to  record  the 
assets  and  the  liabilities  with  which  he 
begins  business,  as  supported  by  an- 
alyses and  other  documents  now  on 
file,  reference  to  which  is  hereby  made. 

I  Land  and  Buildings $6,000.00 

3  Furniture  and  Fixtures  as  per  appraisal. .  915.00 

5  Horse,  Wagon  and  Harness 750.00 

6  Merchandise  Inventory  (as  per  inventory 

book)     3.435-00 

7  Cash  in  bank  and  in  office  (as  per  bank 

certificate  and  physical  count) 3,470.00 

10      Notes  Receivable 50.00 

13-30      Sundry  Customers  (as  per  list) 995-00 

60  To  First  Bond  and  Mortgage  Payable.                      $2,500.00 

62  Notes    Payable 2,000.00 

80-90  Sundry  Creditors  (as  per  list) ....                        1,800.00 

100  Charles  Adams,  Capital 9,315.00 

In  regard  to  the  sundry  customers  and  creditors,  they 
would  be  stated  individually,  and  posted  from  the  journal 
or  stated  as  shown  above  and  posted  from  the  list. 


CHAPTER  VII 

ACCOUNTING  SYSTEMS— TRIPLE  AND  QUAD- 
RUPLE ENTRY 

Logismography 

The  respect  which  the  accountants  of  continental 
Europe  have  for  the  journal,  may  or  may  not  be  due  to  the 
stringent  requirements  of  fiscal  laws;  whatever  its  cause, 
it  has  greatly  complicated  the  application  of  bookkeeping 
to  modern  conditions.  In  1869,  the  enactment  of  the 
Italian  law  making  compulsory  the  adoption  of  double- 
entry  bookkeeping  by  the  Italian  government,  found  the 
native  accountants  fretting  under  what  they  called  the 
lack  of  elasticity  of  the  new  system.  In  1872,  the  chief 
accountant  of  the  War  Department  of  Italy,  Giuseppe  Cer- 
boni,  introduced  a  new  system  of  bookkeeping,  which  he 
called  Logismography;  that  is  to  say,  the  logical  expres- 
sion of  bookkeeping  facts. 

Cerboni  enunciated  what  is  known  in  Europe  as  "The 
Cerbonian  Doctrine,"  generally  referred  to  in  English- 
speaking  countries  as  "the  personalistic  theory  of  ac- 
counts." He  claimed  that  it  was  inadmissible  that  the 
proprietor  should  be  debited  with  his  assets,  i.e.,  charged 
with  what  he  owns,  and  credited  with  his  liabilities,  and 
further  credited  with  the  excess  of  his  assets  over  his  lia- 
bilities. He  advanced  the  theory  that  the  business  repre- 
sents the  aggregate  of  the  persons  who  are  intrusted  with 
the  wealth  of  the  proprietor,  or  who  have  intrusted  the 
proprietor  with  part  of  their  wealth.  Hence,  instead  of 
debiting  and  crediting  accounts,  he  suggested  debits  and 

80 


TRIPLE    AND    QUADRUPLE    ENTRY  gl 

credits  to  the  cashier,  the  storekeeper,  the  manager  of  the 
building,  the  mortgagee,  the  banker,  etc.,  etc.  This  led 
to  the  division  of  the  general  ledger  into  three  parts,  as 
follows: 

1.  Containing  accounts  of  the  proprietor,  with  each 

one  of  the  values  invested  by  him  in  the  busi- 
ness, and  with  each  one  of  the  values  which  he 
owed. 

2.  Containing  accounts  with  the  persons  who  held 

the  values  invested  by  the  proprietor  in  the 
business,  or  who  held  claims  against  him. 

3.  Containing  accounts  showing  the  causes  for  the 

fluctuations  reflected  by  the  values  contained 
in  Part  I. 
It  will  be  seen  from  the  foregoing  that  in  some  in- 
stances, triple  and  quadruple  entries  had  to  be  resorted  to. 
For  instance: 

A  building  costing  $5,000  is  destroyed  by  fire.  The 
journal  entries  might  be  as  follows: 

Ledger  I 

Proprietor  $5,000.00 

To  Building $5,000.00 

Ledger  II 

To   John    Doe,    Keeper   of 

Building   $5,000.00 

Ledger  III 

Losses  due  to  fire $5,000.00 

As  a  result  of  this  complicated  system,  the  facts  ob- 
tainable at  the  end  of  the  period  in  regard  to  the  loss  by 
fire  were: 

I.  The  capital  of  the  proprietor  had  been  reduced 
by  $5,000,  through  the  destruction  of  the 
building. 


82        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

2.  John  Doe  was  discharged  from  his  liability  to  the 

proprietor  in  so  far  as  the  value  of  the  building 
intrusted  to  him  was  concerned. 

3.  The  cause  for  the  impairment  of  the  proprietor's 

capital  was  a  fire. 

The  same  facts  could  be  obtained  by  double  entry,  in 
a  much  simpler  way,  and  the  system  was  abandoned  by 
the  Italian  government  at  the  death  of  its  inventor. 

Statmography 

This  system,  which  was  invented  by  Emanuele  Pisani, 
a  professor  at  the  High  School  of  Commerce  of  Bari,  Italy, 
has  for  its  object,  in  the  words  of  Pisani  himself,  to  keep 
books  "through  the  medium  of  double,  triple,  and  quad- 
ruple balances."  The  system  is  supposed  to  be  ideally 
adapted  to  the  needs  of  governments,  municipalities,  and 
all  industries  managed  by  representatives  of  the  people  for 
the  good  of  the  people.  It  attempts  to  differentiate  and 
harmonize  three  classes  of  facts: 

1.  The  "dynamic"  facts,  which  consist  of  the  incom- 

ing and  outgoing  transactions  of  the  account- 
ing period. 

2.  The  "statical"  facts,  which  might  be  called  the 

"status  quo"  of  the  business  at  the  beginning 
of  the  period,  as  influenced  by  losses  which 
have  no  connection  with  the  operations  of  the 
business  and  are  due  to  acts  of  God,  or  to  mis- 
management of  employees,  etc. 

3.  The  "statico-dynamic"  facts,  which  are  nothing 

more  than  the  causes  which  have  brought 
about  the  increases  and  decreases  of  assets  and 
liabilities. 

It  does  not  appear  that  statmography  has  as  yet  in- 
duced European  municipalities  or  government  banks  to 


TRIPLE    AND    QUADRUPLE    ENTRY  83 

abandon  the  older  system  of  double  entry,  but  it  must  be 
said  that  it  has  greatly  influenced  the  terminology  of  their 
financial  statements. 

The  subject  of  the  quadruple-entry  system  has  been  in- 
troduced in  this  book,  because  it  serves  to  emphasize  the 
fact  that  the  great  aim  of  accounting  the  world  over  is 
so  to  analyze  financial  transactions  that  they  will  not  only 
measure  the  extent  of  the  success  or  of  the  failure  of  the 
business  venture,  but  also  to  classify  the  causes  and  pre- 
sent them  logically  in  order  that  they  may  give  adminis- 
trative information,  and  make  them  express  in  their  own 
way  the  history  of  every  department  of  the  organization. 


CHAPTER  VIII 

THE   FINANCIAL   BOOKS— THE   JOURNALS 

The  books  which  are  necessary  in  order  that  accounts 
may  be  kept  successfully,  are: 

1.  The  Journal 

2.  The  Ledger 

The  Journal 

The  original  journal  was  not  a  book  of  first  record. 
The  transactions  were  entered,  as  they  occurred,  in  a 
species  of  narrative  book,  '7a  prima  nota,"  or  preliminary 
record,  the  only  claim  of  which  was  to  be  thorough  and 
chronological.  From  this  "prima  nota,"  which  might  be 
called  "the  blotter"  or  "day  book,"  the  transactions  were 
transferred  to  the  journal  in  such  a  manner  as  to  gather  as 
far  as  possible  the  facts  of  homogeneous  nature. 

The  journal  originally  contained  only  one  column,  the 
debits  and  credits  being  earmarked,  close  to  the  column, 
by  means  of  the  contractions  Dr.  (Debtor)  and  Cr. 
(Creditor).  In  1796,  John  of  Bristol  advocated  the  use 
of  two  journal  columns,  one  for  debits  and  one  for  credits. 
This  gave  to  the  journal  its  present  form: 

Posting 
Date         Accounts  and  Explanations        Reference  Dr.  Cr. 

1912 

Jan.  I     Promissory  Notes  Receivable 15  $150.00 

To  John  Dorman 75  $150.00 

For  settlement  by  note  (dated 
1/1/12,  due  3/1/12,  indorsed 
by  V.  Curtis)  of  his  account 
current 

84 


THE    JOURNALS  85 

The  addition  of  the  second  column  had  the  advantage 
of  minimizing  the  possibility  of  error,  since  it  made  the 
book  capable  of  being  brought  to  a  balance  showing  that 
the  debits  equalled  the  credits. 

With  the  possible  exception  of  certain  economic  types 
of  organization  where  the  tremendous  mass  of  detail  to  be 
handled,  and  the  multiplicity  of  its  sources,  make  its  reten- 
tion by  the  auditor  a  matter  of  convenience,  the  journal 
in  its  original  form  is  a  thing  of  the  past.  One  after  an- 
other, its  component  parts  have  been  detached  and  built 
up  into  separate  journals  bearing  titles  which,  to  the  lay- 
man, do  not  even  suggest  the  common  origin  of  the 
books.  The  journal,  as  such,  is  still  intrusted  with  the 
recording  of  opening  entries,  correcting  or  adjusting  en- 
tries, and  closing  entries.  This,  interpreted  in  the  light  of 
what  has  been  said  in  connection  with  double  entry,  means 
that  the  functions  of  the  present-day  journal  are  to  estab- 
lish the  original  equilibrium;  to  harmonize  such  dis- 
crepancies as  occur  during  the  fiscal  period  through  the 
erroneous  recording  of  transactions;  and,  at  the  end  of  the 
fiscal  period,  to  gather  all  nominal  accounts  to  be  closed 
into  the  Profit  and  Loss  account,  to  close  them,  and,  in 
turn,  to  close  the  Profit  and  Loss  account  to  the  debit  or 
credit  of  the  proprietor,  or  of  an  account  representing  un- 
drawn or  undistributed  profits. 

The  Sub- Journals 

The  several  steps  taken  in  the  segregation  of  the 
journal  accounts  have  theoretically  been  as  follows : 

1.  The  removal  of  all  cash  transactions 

2.  The  removal  of  all  transactions  referring  to  mer- 

chandise 

3.  The  removal  of  all  personal  transactions  not  in- 

cluded in  I  and  2 


85        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

1.  The  removal  of  all  cash   transactions  from  the 
journal  has  eliminated: 

a.  The  payments  to  creditors,   involving  discounts, 

allowances  and  rebates,  and,  in  some  instances, 
return  of  goods. 

b.  The  payments  to  customers  in  the  form  of  refunds. 

c.  Receipts    from     customers,    involving    discounts, 

allowances  and  rebates,  and,  in  some  instances, 
return  of  goods. 

d.  Receipts  from  creditors  in  the  form  of  refunds. 

e.  Payments  for  expenses  of  conducting  the  busi- 

ness, expenses  incidental  to  the  receipt  or  ship- 
ment of  merchandise,  payments  for  services 
rendered,  etc. 

f.  The  receipts  of  borrowed  money,  the  proceeds  of 

the  sale  of  assets,  or  of  the  discounting  of 
promissory  notes,  etc.,  etc. 

g.  The  disbursements  incident  to  the  liquidation  of 

liabilities  incurred  through  loans,  etc.,  to  the 
dishonor  of  discounted  paper,  to  the  with- 
drawal of  funds  by  the  proprietor,  etc.,  etc. 

2.  The  removal  of  all  merchandise  transactions  from 
the  journal  has  eliminated: 

a.  Purchases,  and  returns  of  part  thereof  by  the  pro- 

prietor. 

b.  Sales,  and  returns  of  part  thereof  to  the  proprietor. 

3.  The  removal  of  personal  transactions  from  the 
journal  has  eliminated: 

a.  The  receipt,  or  issuance,  of  promissory  notes, 
drafts  receivable  or  payable,  and  other  commer- 
cial paper;  and,  generally,  the  recording  of  all 


THE    JOURNALS  87 

other  transactions  not  covered  by  the  fore- 
going. 

The  dissociated  components  of  the  original  journal 
have  been  built  up  into  a  complete  system  of  journals  af- 
fording a  limitless  distribution  of  work,  besides  giving 
without  effort  a  complete  classification  of  transactions. 
Thus  we  have: 

1.  The  cash  journal  (cash  book)  itself,  divided  into 

two  parts,  one  for  the  debits  to  cash  and 
credits  to  other  accounts;  the  other  for 
credits  to  cash  and  debits  to  other  accounts. 

2.  The  merchandise  journal,  divided  into  as  many 

subdivisions  as  the  business  comports;  for  in- 
stance: 

a.  Purchase  Journal 

b.  Sales  Journal 

c.  Returned  Purchases 

d.  Returned  Sales 

3.  The  promissory  notes  journal,  divided  into  two 

parts: 

a.  Notes  Receivable 

b.  Notes  Payable 

4.  The  general  journal,  in  which  are  recorded  all 

transactions  which  cannot  find  expression  in 
the  other  journals. 

The  "Modern  Recording  Media"  in  the  following  dia- 
gram are  generally  known  to  accountants  as  "books  of 
original  entry,"  that  is  to  say,  books  in  which  transac- 
tions pertaining  to  the  subject  matter  indicated  by  the 
title  of  the  book  are  entered  as  they  occur.  These  books 
are,  as  a  rule,  supposed  to  be  used  periodically  as  posting 
media. 


88    THEORY  AND  TECHNIQUE  OF  ACCOUNTS 


Component  Parts 

Modern 

Contents  of  Modern 

OF 

Recording 

Media   (Method 

Original  Journal 

Media 

OF  Handling) 

Opening  Entries : 

Assets 
Liabilities 

Proprietor's    Net    Invest- 
ment 

General 
Journal 

Dr.    Assets 

J  Liabilities 
C"^-  ]  Proprietor 

Merchandise    Transactions : 

Purchase 

Dr.     Merchandise 

Purchases 

Journal 

Cr.    Creditors 

Sales 

Sales 

Dr.    Customers 

Journal 

Cr.    Merchandise 

Returned  Purchases 

Returned 

Dr.     Creditors 

Purchase 

Cr.    Merchandise 

Journal 

Returned  Sales 

Returned 

Dr.     Merchandise 

Sales 

Cr.    Customers 

Journal 

Cash  Transactions : 

Debit  Side : 

Receipts  from  Customers 

Dr. 

Receipts    from    Creditors 

Net  Cash 

(refunds) 

{  Allowances 

Receipts    from    all    other 

*-^  Discounts 

sources 

(  Rebates 

Cr. 

Incidental  Transactions : 

Customers 

Discounts     J 
Allowances  (■  ^° 
Rebates        )  Customers 

Cash 
Journal, 

Creditors  (refunds) 
Other   Ledger   Accounts* 

Other  Discounts 

divided 

Credit  Side: 

Disbursements   to   Credi- 
tors 
Disbursements     to     Cus- 

into two 
sections 

Cr. 

Net  Cash 

{  Discounts 
*  )   Rebates 
(  Allowances 

tomers  (refunds) 
Disbursements    for    all 

other  causes 

Dr. 

Creditors 
Customers  (refunds) 

Incidental  Transactions : 
Discounts     ) 
Allowances  1  ^^^"^ 

Rebates            Creditors 

Other   Ledger  Accounts* 

•  Subject  to  monthly  analysis  and  detail  posting  therefrom 


THE    JOURNALS 


89 


Component  Parts 

MODERN 

Contents  of  Modern 

OF 

Recording 

Media   (Method 

Original  Journal 

Media 

OF  Handling) 

Transactions   with 

Persons 

Notes  and 

First   Part: 

Not  Included  Above: 

Bills 

Dr.     Notes  and  Bills  Re- 

Notes  and   Bills 

Receiv- 

Receivable 

ceivable 

able  and  Payable 

and 

Cr.    Customers 

Payable 

Second  Part: 

Journal, 

Cr.    Notes  and  Bills  Pay- 

in two 

able 

sections 

Dr.    Creditors 

Dr.    Account    over-cred- 

General 

ited 

Correcting  Entries 

Journal 

Cr.    Account  under-cred- 
ited 

Close    all    the    accounts 

which  are  raised  during  the 

accounting  period  to  reflect 

the  causes  for  increases  and 

decreases  of  invested  values, 

by  crediting  individually  the 

accounts  showing  debit  bal- 

ances   and    debiting    Profit 

Closing  Entries 

General 

and  Loss  with  the  aggregate 

Journal 

amount;  reverse  the  proce- 
dure for  accounts  showing 
credit  balances.  Close  Profit 
and  Loss  by  debiting  it  with 
the  net  gain  and  crediting 
proprietorship.  If  the  re- 
sult of  operations  is  a  loss, 
credit  Profit  and  Loss  and 
debit  proprietorship. 

The  dissecting  of  the  original  journal  into  its  component 
parts,  may  or  may  not  have  been  accomplished  as  a  direct 
result  of  the  organization  of  business  into  departments. 
Still,  the  necessity  of  adapting  the  financial  accounting 


go        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

records  to  the  needs  of  the  various  operating  branches  of 
the  administration,  and  to  the  ever-increasing  demands 
of  executives  for  multiple,  accurate,  and  readily  obtain- 
able information,  must  have  been  felt  keenly  by  the  count- 
ing house,  if  we  are  to  base  our  judgment  upon  the  quan- 
tity, and  the  analytical  construction  of  the  records  which 
it  hac  evolved  and  placed  at  the  disposal  of  the  various 
departments. 

Purchasing  Department — Purchase  Journal 

Irrespective  of  the  extent  of  its  own  activities,  which 
it  must  know  at  all  events,  the  purchasing  department, 
being  the  purveyor  of  the  factory  as  well  as  of  the  other 
departments  (such  as  shipping,  selling,  and  administra- 
tive), must  supply  the  accounting  division  with  its  quota 
of  the  facts  necessary  to  ascertain  the  cost  of  operations. 
The  information  required  may  extend  not  only  to  the  de- 
partments for  whose  account  the  purchases  are  made,  but, 
as  well,  to  the  classes  of  goods  bought;  whatever  it  may 
be,  the  purchasing  department  finds  in  the  purchase  jour- 
nal an  adaptable  and  efficient  helper,  as  will  be  seen  by 
reference  to  the  accompanying  Figures  lo  and  ii. 

In  connection  with  the  purchase  journal,  there  may 
be  kept,  if  occasion  demands,  a  "returned"  purchase 
journal  built  up  on  precisely  the  same  lines  as  the  pur- 
chase journal.  If  the  returns  are  few,  a  section  of  the 
purchase  journal  may  be  assigned  to  them ;  if  they  are  in- 
significant, they  might  be  recorded  by  the  accounting 
division  in  the  general  journal  from  data  supplied  by  the 
purchasing  department. 

Sales  Department — Sales  Journal 

The  sales  department,  outside  of  the  data  which  it 
must  furnish  to  the  accounting  division,  may  be  vitally 
interested  in: 


THE    JOURNALS 


91 


purchase:  journal 

A-  MANUFACTURING  MATERIALS  &  SUPPLIES. 

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1.  Statistics  of  sales  by  communities 

2.  Statistics  of  sales  by  salesman  and  district,  as 

distinguished  from  sales  made  by  the  home 
office 

Figures  12  and  13  illustrate  the  adaptability  of  the 
journal  to  the  requirements  of  the  sales  department. 
The  remarks  concerning  "purchases  returned"  under  the 
discussion  of  the  purchase  journal,  apply  as  well  to  sales 
returned. 

Treasurer's  Department — Cash  Journal 

The  primitive  cash  book  was  nothing  more  than  a 
memorandum  account  with  cash,  in  which  the  receipts 
appeared  on  the  left  and  the  disbursements  on  the  right. 
From  time  to  time  the  transactions  were  analyzed  and 
recorded  in  the  journal.  The  disadvantage  of  the  book 
lay,  not  only  in  the  duplication  of  work  which  it  neces- 
sitated, but,  as  well,  in  the  cross  entries  which  had  to  be 
made  under  certain  not  uncommon  conditions,  such,  for 
instance,  as  a  cash  settlement  involving  the  giving  or  taking 
of  a  cash  discount. 

To  illustrate  :  Customer  A,  whose  indebtedness  amounted 
to,  say,  $200,  remitted  within  ten  days,  and  taking  advantage 
of  the  cash  discount,  sent  $196.  The  entries  were  made  as 
follows : 


Cash  Book 


Dr. 

Cr. 

Date 

Name  and 
Explanation           Amt. 

Date 

Name  and 
Explanation 

Amt. 

1914 
Feb.  I 

Customer  A  (bill  of 
Jan.  25,  1914) $200.00 

1914 
Feb.  I 

Customer     A     (dis- 
count on  bill,  Jan. 
25,  1914) 

$4.00 

94 


THEORY    AND    TECHNIQUE    OF    ACCOUNTS 


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96        THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

Journal 

Names  and  Explanations  Dr.  Cr. 

Feb.  I,  1914 

Cash  $200.00 

To  Customer  A $200.00 

For  settlement  in  cash  of  our  bill  of  Jan.  25,  1914, 
subject  to  a  cash  discount  of  2%  for  10  days. 

Discount $400 

To  Cash $400 

For  discount  of  2%  on  $200.00  to  Customer  A  on 
our  bill  of  Jan.  25,  1914. 

The  foregoing  method  of  handling  the  cash  book  was 
open  to  the  objection  that  it  did  not  show  the  actual  cash 
transactions  as  they  occurred,  and  that  it  rendered  the 
audit  of  the  cashier's  accounts  very  lengthy  and  compli- 
cated. This  objection,  serious  as  it  may  have  been,  was 
as  nothing  to  the  defects  developed  by  the  books  so  kept 
when,  having  evolved  with  the  business,  the  cashier  be- 
came treasurer,  that  is  to  say,  when  the  clerk  of  the  shop 
became  an  officer  of  the  now  highly  organized  body 
economic.  The  treasurer  needed  information  of  the  most 
varied  nature,  and  he  had  to  make  his  records  reflect  it. 
He  quickly  realized  that  if  the  receiving  and  disbursing 
of  cash  gave  rise  to  deductions  from  the  face  of  the 
amounts  to  be  received  and  paid  out  (in  the  form  of  dis- 
counts, allowances  for  claims,  returns  of  goods  sold  or 
purchased,  etc.),  it  was  possible  to  transform  the  cash 
book  into  a  cash  journal  which  would  not  only  record 
accurately  the  status  of  the  asset  "Cash,"  as  affected  by 
the  transactions  of  the  period,  but  indicate  as  well  the 
accounts  which  were  to  be  debited  (or  credited)  and  main- 
tain equilibrium  between  cash  and  the  accounts  which 
were  to  be  credited  (or  debited)  as  a  result  of  the  cash 
transactions. 

Accordingly,  he  built  up  the  cash  journal  (Figures  14, 
15),  which  provides  on  one  side  of  the  page,  columns  for 


THE    JOURNALS 


97 


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accounts  to  be  debited  and  accounts  to  be  credited;  and 
on  the  other  side,  cokimns  for  accounts  to  be  credited, 
and  accounts  to  be  debited.  This  journal,  like  all  others, 
is  capable  of  limitless  extensions  to  suit  particular  cases. 

Petty  Cash  Book 

When  used  by  the  cashier  as  a  memorandum  of  petty 
disbursements,  the  petty  cash  book  has  no  particular 
anatomy.  All  it  is  intended  to  do  is  to  record  faithfully 
the  cash  transactions  which,  while  small  in  amount,  occur 
so  frequently  as  to  make  their  daily  posting  a  matter  of 
inconvenience.  The  disbursements  may  be  recorded  in 
the  petty  cash  book  in  any  way  which  is  deemed  satis- 
factory. Monthly  or  oftener,  an  analysis  is  made  which 
forms  the  basis  of  an  entry  (properly  supported  by 
vouchers)  to  appear  in  the  general  cash  journal. 

When  used  in  connection  with  all  disbursements  made 
otherwise  than  by  check,  the  petty  cash  book  may  be- 
come a  journal  in  the  true  sense  of  the  word  and  be  used 
as  a  posting  medium,  in  so  far  at  least  as  the  disburse- 
ments are  concerned.  It  is,  in  this  case,  nothing  more 
than  a  portion  of  the  general  cash  journal  assigned  to  dis- 
bursements for  petty  expenses. 

Under  the  "imprest  fund"  system  of  providing  for 
petty  cash  disbursements  (of  which  we  will  speak  later)  a 
book  such  as  shown  in  Figure  i6  could  be  used  to  advan- 
tage; it  would  not,  however,  be  treated  as  a  posting 
medium,  but  as  an  analytical  record  from  which  the  re- 
quired data  could  be  readily  obtained. 

Notes  and  Bills  Journal 

With  the  possible  exception  of  the  pay-roll  book, 
which  is  discussed  later,  the  recorder  of  the  notes  and 
bills  receivable  and  payable  is  probably  the  book  of  orig- 


100 


THEORY  AND  TECHNIQUE  OF  ACCOUNTS 


PETTY    CASH    JOUI^NAL 

(IN    PETTY  CASH  BOOK) 

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103 


I 


inal  entry  which  suggests  in  the  least  degree  the  idea  of 
the  journal.  This  may  be  due  to  the  facts:  first,  that  a 
great  deal  of  the  information  which  it  contains  is  purely 
statistical,  and  in  no  way  related  to  journalizing;  second, 
that  the  data  concerning  the  disposition  of  the  notes 
prior  to,  or  at,  the  time  of  their  maturity,  are  also  re- 
flected by  the  cash  journal  and  posted  therefrom;  third, 
that,  generally  speaking,  bookkeepers  use  the  book 
merely  as  a  memorandum  which  gives  the  facts  necessary 
for  the  monthly  recording  in  the  general  journal  of  the 
transactions  in  promissory  notes.  Still,  irrespective  of 
the  great  value  which  it  derives  from  the  thorough  char- 
acter of  the  information  which  it  is  capable  of  giving,  the 
notes  and  bills  journal,  when  properly  constructed,  con- 
stitutes an  excellent  posting  medium  for  transactions  in- 
volving the  receipt  or  issue  of  promissory  notes. 

It  will  be  seen  from  Figures  17,  18  that  the  notes  and 
bills  book  is  essentially  a  journal,  since  under  the  heading 
"Amount"  it  provides: 

I.     In  the  Notes  and  Bills  Receivable  section,  for: 
Debits  to: 

a.     "Notes  and  Bills  Receivable"   (asset  ac- 
count) 
Credits  to: 

a.  Customers  who  have  executed  or  assigned 

the  notes 

b.  The  interest  carried  by  the  notes,  and 
added  to  the  amount  of  principal 
which  settles  for  the  customers'  in- 
debtedness 

c.  Other  ledger  accounts  which  might  be 
affected  by  the  incoming  of  a  promis- 
sory note 


104      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

2.     In  the  Notes  and  Bills  Payable  section,  for : 
Credits  to: 

a.     "Notes  and  Bills  Payable"   (liability  ac- 
count) 

Debits  to: 

a.  Creditors  in  whose  favor  the  notes  are 

executed 

b.  The  interest  (if  any)  carried  by  the  note 

on  its  face 

c.  Other   ledger   accounts   which   might   be 

affected  by  the  outgoing  of  a  promis- 
sory note 

Pa;>  Roll  Journal 

in  its  simplest  form,  and  when  used  by  concerns  which 
do  not  keep  their  books  on  the  accrued  basis,  and  whose 
organization  is  not  departmentalized,  the  pay-roll  book 
can  hardly  be  said  to  be  a  journal,  since  it  merely  states 
the  names  of  the  employees,  and  the  amounts  earned  by 
them  during  a  given  period.    (See  Figure  19.) 

In  such  cases  as  the  above,  the  book  is  merely  a  mem- 
orandum record,  gathering  weekly  or  monthly,  the  de- 
tails which  will  support  the  entries  appearing  in  the  cash 
journal  to  the  credit  of  cash  and  to  the  debit  of  office 
salaries,  or  such  other  accounts  as  are  indicated  by  the 
analysis  of  the  pay-roll  book  in  so  far  as  official  capacity 
is  concerned. 

When,  however,  departmental  organization  exists 
and  when,  besides,  the  accrued  liabilities  (or  assets)  are 
placed  on  the  books  at  the  end  of  each  weekly  or  monthly 
division  of  the  accounting  period,  the  pay-roll  book  may 
be  developed  into  an  invaluable  book  of  original  entry. 
(See  Figure  20.) 


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THE    JOURNALS  109 

The  pay-roll  journal  shown  in  Figure  20  is  designed 
for  a  warehouse.  During  certain  seasons,  certain  depart- 
ments are  very  active,  while  others  are  slack;  the  men  of 
one  department  may  be  put  to  work  in  other  depart- 
ments. This  necessitates  the  distribution  columns,  which 
are  so  headed  as  to  show  the  ledger  account  to  which  the 
total  of  the  items  appearing  therein,  will  have  to  be 
debited. 

The  adaptability  of  the  pay-roll  journal  to  the  require- 
ments of  the  treasurer's  department,  is  illustrated  by 
Figure  21.  The  form  is  supposed  to  be  "loose-leaf"  and 
used  by  concerns  which  find  it  convenient  to  have  the  em- 
ployees paid  in  the  department  in  which  they  work. 

Specially  Ruled  Journals 

One  sometimes  finds,  in  certain  businesses,  journals 
providing  on  either  side  of  the  space  allotted  to  the  ex- 
planations of  the  entries,  special  debit  and  credit  columns 
in  which  are  entered  the  names  of  the  active  accounts, 
one  column  being  reserved  for  inactive  ledger  accounts. 
These  books  are  sometimes  referred  to  as  day-book 
journals,  because  they  unite  in  a  single  book,  the  original 
blotter,  that  is  to  say,  the  chronological  and  historical 
records,  and  all  the  components  of  the  original  journal  in 
which  the  data  of  the  blotter  used  to  be  classified. 


CHAPTER   IX 

THE    FINANCIAL    BOOKS— THE    LEDGER    AND 
VOUCHER     RECORD 

The  Structure  of  the  Ledger 

The  ledger  has  been  aptly  called  by  the  Italians 
"Libro  Maestro."  It  is,  indeed,  the  master  book,  or  the 
book  of  the  master  of  the  business;  the  proprietor  should 
be  able  to  find  in  it  the  synthetic  grouping  of  the  analytic 
labor  of  the  journal. 

We  have  referred  to  the  journal  as  "the  scales"  in 
which  the  transactions  are  weighed  and  classified  as  be- 
tween debits  and  credits.  We  might  compare  the  ledger 
to  a  chest  of  drawers,  each  unit  of  which  is  divided  into 
two  vertical  sections,  the  left  being  known  as  the  debit 
side,  and  the  right,  as  the  credit  side.  Each  drawer  is 
given  a  name  indicative  of  the  subject  matter  which  will 
be  placed  therein  as  soon  as  the  iournal  has  classified  the 
transactions. 

In  order  that  information  concerning  the  contents  of 
each  drawer  may  be  readily  obtained,  each  side  of  it  is 
subdivided  into  four  compartments  of  unequal  dimen- 
sions, intended  to  contain: 

1.  The  date  of  the  transaction 

2.  The  explanation  or  name  of  the  value  which  the 

journal  has  classified  as  the  counterpart  of  the 
one  to  be  placed  in  the  particular  drawer  in 
question 

no 


THE    LEDGER    AND    VOUCHER    RECORD 


III 


3.  The  particular  journal  scales  which  attended  to 

the  weighing  of  the  transaction  as  a  whole 

4.  The  money  value  of  every  item 

Thus  we  have  the  ledger  account  form  which  usage 
has  consecrated: 

Name  of  Account* 


Dr. 

Cr. 

Date 

Explanation 

Refer- 
ence 

Amt. 

Date 

Explanation 

Refer- 
ence 

Amt. 

Variations  of  the  Standard  Ledger 

Every  book  of  accounts  which  is  built  upon  lines 
similar  to  the  ruling  given  above  for  the  ledger  account, 
is  said  to  be  "ledger-ruled." 

A  slight  alteration  of  the  conventional  frame  has  been 
made  in  what  is  generally  known  as  "The  Boston 
Ledger,"  and,  less  commonly,  as  "The  Bank  Ledger." 
This  book  is  the  result  of  the  demand  of  certain  types  of 
financial  organization  for  daily  balances;  it  places  the 
credit  column  alongside  of  the  debit  column,  and  intro- 
duces a  third  column  for  balances.  The  accounts  are 
arranged,  according  to  individual  preference,  one,  two,  or 
four  to  the  page.    An  example  is  given  in  Figure  23. 


*  In  practice,  the  hejidings  appearing  in  the  columns  are  omitted. 


112      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 


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114   THEORY  AND  TECHNIQUE  OF  ACCOUNTS 

Storage  warehouses,  dairies,  real  estate  agencies,  and 
other  businesses  whose  clients  and  patrons  are  many,  but 
in  which  the  monthly  transactions  are  comparatively  few, 


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have  developed  the  Boston  ledger  to  such  an  extent  that, 
if  an  error  occurs  in  the  posting,  it  will  be  located  at  once 
by  comparing  the  footings  of  the  ledger  columns  with 


THE    LEDGER    AND    VOUCHER    RECORD  115 

those  of  the  corresponding  columns  of  the  specially  ruled 
journal.  The  ledger  so  developed  (Figures  24,  25)  is  a 
loose-leaf  book,  composed  of  long  sheets  and  short  sheets, 
containing,  according  to  the  importance  of  the  accounts  to 
be  carried,  one,  three,  five,  ten,  or  twenty  accounts  to  the 
page. 

The  long  sheets  are  used  as  form  sheets  and  contain 
the  number  of  the  customer  or  client,  his  name  and  ad- 
dress, and  the  headings  of  the  different  spaces  and 
columns.  The  short  sheets  are  six  in  number  for  every 
long  sheet  and  contain  neither  names  nor  headings.  One 
side  of  each  sheet  is  used  for  one  month.  Each  sheet  be- 
gins with  the  initial  balance  for  the  month,  and  ends  with 
the  closing  balance  for  that  month,  the  debit  and  credit 
transactions  being  given  as  many  columns  as  there  are 
possible  classes  of  charges  or  credits.  Each  account  can 
be  added  monthly,  both  horizontally  and  vertically.  The 
footings  of  each  column  of  each  and  every  one  of  the 
three,  five,  ten,  or  twenty  accounts  which  the  page  con- 
tains, are  added  at  the  end  of  the  page,  and  reflected 
monthly  by  a  special  recapitulation  sheet,  the  totals  of 
which  must  agree,  by  columns,  with  the  footings  of  the 
corresponding  columns  of  the  books  of  original  entry. 

The  great  advantages  claimed  for  the  book  are: 

1.  It  permits  of  monthly  customers'  statements  be- 

ing made  by  the  bookkeepers  without  refer- 
ence to  books  of  original  entry. 

2.  If  the  customers  ledgers  do  not  agree  with  the 

controlling  account  in  the  general  ledger,  the 
differences  can  be  traced  at  once  to  the  par- 
ticular column  where  they  originated,  by  com- 
paring the  results  of  the  sundry  columns  of  the 
customers  ledgers  with  the  sundry  columns  of 
the  books  of  original  entry. 


•Il6      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

3.  In  connection  with  the  current  ledger,  there  is 
kept  a  "transfer  ledger"  which,  being  provided 
with  duplicate  long  sheets,  keeps  in  any  single 
book,  for  as  many  years  as  may  be  required, 
the  monthly  history  of  all  the  transactions 
with  all  customers. 

Private  Ledger 

If  the  business  is  of  such  a  nature  as  to  make  it  advis- 
able to  prevent  the  employees  from  obtaining  connected 
information  concerning  its  various  phases,  the  general 
ledger  is  relieved  of  all  the  facts  which  it  is  desired  to  keep 
secret.  The  vital  data  are  kept  in  a  private  ledger  which 
is  posted  by  the  head  of  the  concern,  the  auditor,  or  a 
confidential  clerk,  from  the  results  of  the  books  of  original 
entry.  The  book  is  placed  in  equilibrium  by  adding  to 
the  accounts,  with  such  values  as  it  contains,  an  account 
known  as  "General  Ledger"  which  is  debited  (or 
credited)  with  the  net  of  the  values  recorded  by  the  latter 
book.  Equilibrium  is  maintained  by  debiting  or  crediting 
the  General  Ledger  account  with  the  net  of  the  fluctua- 
tions of  the  values  which  it  contains. 

If  the  facts  to  be  kept  secret  relate  to  profits,  it  is 
likely  that  the  books  of  original  entry  will  be  made  as 
little  analytical  as  possible.  It  is  also  probable  that 
analyses  will  be  made  by  the  keeper  of  the  private  ledger, 
and  their  results  entered  in  a  private  journal. 

In  what  is  left  of  the  general  ledger,  there  is  kept  an 
account  with  the  private  book,  which  is  debited  with  the 
same  amount  with  which  the  private  ledger  credits  the 
general  ledger,  and  vice  versa.  The  following  illustration 
will  show  the  operation  of  the  private  ledger  and  the  rela- 
tion of  that  book  to  the  general  ledger.  This  is  especially 
exemplified  by  the  presentation  of  the  general  ledger  ac- 
counts as  they  would  appear  if  no  private  ledger  were  kept. 


THE    LEDGER    AND    VOUCHER    RECORD 


117 


Private  Ledger  of  A,  B.  C.  Partners 
Trial  Balance 

(After  closing)  . 


Plant  &  Equipment $20,000.00 

Furniture  &  Fixtures..  3,000.00 

Drawings — C   4,500.00 

Special  Deposits 10,000.00 

Patents 20,000.00 

Investments 8,000.00 

General  Ledger 15,500.00 


51,000.00 


Capital — A    $15,000.00 

Capital — B 16,000.00 

Capital — C 22,000.00 

Undivided  Profits 28,000.00 


51,000.00 


General  Ledger  of  A.  B.  C. 
Trial  Balance 

(After  closing) 


Partners 


Cash  &  Petty  Cash...  $    7,100.00 

Inventory  of  Mdse 10,000.00 

Customers 34,680.00 

(Individual    accounts 

kept    in    customers 

ledger) 


$51,780.00 


Mortgage  Payable $  7,000.00 

Accounts  Payable 23,680.00 

(Individual    accounts 

kept     in     creditors 

ledger) 

Notes  Payable 5,000.00 

Wages  Payable 600.00 

Private  Ledger 15,500.00 


$51,780.00 


General  Ledger  of  A,  B.  C.  Partners* 
Trial  Balance 

(After  closing) 


Cash  &  Petty  Cash... 

Plant  &  Equipment 

Furniture  &  Fixtures. 

Inventory  of  Mdse 

Customers 

Drawings — C  

Special  Deposits 

Patents 

Investments 


.$    7,100.00 

20,000.00 

3,000.00 

.     10,000.00 

34,680.00 

4,500.00 

.     10,000.00 

.     20,000.00 

8,000.00 

$117,280.00 


Capital — A   $  15,000.00 

Capital — B 16,000.00 

Capital — C 22,000.00 

Mortgage  Payable 7,000.00 

Accounts  Payable 23,680.00 

Notes    Payable 5,000.00 

Wages  Payable 600.00 

Undivided  Profits 28,000.00 


$117,280.00 


*  On  the  assumption  that  there  is  no  private  ledger. 


Il8   THEORY  AND  TECHNIQUE  OF  ACCOUNTS 

Voucher  Record 

Originally  a  columnar  purchase  journal,  this  book  has 
been  so  altered  and  extended,  that  it  is  not  uncommon  to 
hear  accountants  refer  to  it  as  a  combination  of  the  pur- 
chase journal  and  creditors  ledger. 

If  we  decline  to  give  the  name  "ledger"  to  any  rec- 
ord other  than  the  time-honored  book  bearing  that  title, 
it  may  still  be  admitted  that  the  voucher  record  seems  to 
combine  two  books.  It  is,  in  fact,  generally  true  that 
where  it  is  used,  no  creditors  ledger,  as  such,  is  kept. 

Upon   close   examination   of   the   mechanism   of   the 
voucher  record,  we  find  that  it  differs  from  the  analytical 
purchase  journal  only  in  that  it  provides  for  the  recording 
of  the  amount  paid  to  the  creditors  and,  in  some  cases,  for 
the  discounts  gained  at  settlement.     Investigating  fur- 
ther, we  find  that  the  forms  usually  submitted  by  writers 
and  by  practising  accountants  fail  to  support  the  claims 
made  for  them,  since  they  do  not  provide  for  returns, 
allowances,  and  other  deductions  which  are  likely  to  be 
made  on  the  face  of  a  bill  at  settlement.    Nor  do  they  pro- 
vide for  settlement  by  promissory  notes,  to  say  nothing 
of  the  many  other  complications  which  may  arise.     We 
must  realize  then  that,  in  connection  with  the  voucher 
record,   there  must  be  kept  memoranda  in  some  form 
whereby  the  status  of  the  account  of  each  creditor  may 
be  readily  ascertained.     Whether  such  memoranda  are 
kept  on  cards  or  on  ordinary  pieces  of  paper  systemati- 
cally filed,  or  whether  they  are  kept  in  a  bound  book  or 
loose-leaf  book,  is  as  immaterial  as  the  name  which  is 
given  to  them  or  to  the  file  which  contains  them.     No 
matter  what  the  system  adopted  may  be,  it  is  to  all  in- 
tents and  purposes  a  ledger.    The  name  ledger  could  be 
given  to  a  vertical  file;  as  a  matter  of  fact,  nothing  comes 
so  near  to  being  an  ideal  ledger  as  the  card  files  kept  by 
life  insurance  companies  in  connection  with  the  premiums 


THE    LEDGER    AND    VOUCHER    RECORD 


110 


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120      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

collected,  overdue,  collectable,  and  uncollectable  under 
the  policies  which  they  have  issued. 

The  most  elaborate  voucher  record  which  ingenuity 
could  devise,  would  fail  as  utterly  as  a  creditors  ledger,  as 
did  the  original  journal.  In  this  latter  book  there  can  be 
found,  if  one  were  tempted  to  look  for  them,  all  the  names 
of  the  creditors  of  the  business,  together  with  the  amount 
of  the  indebtedness  towards  them  which  each  individual 
transaction  brought  about,  and  the  exact  detail  of  the 
settlements  made  with  them.  But  it  was  precisely  be- 
cause no  one  would  ever  have  time  or  patience  to  analyze 
the  record  in  order  to  find  the  true  status  of  any  given 
creditor,  that  the  creditors  ledger  came  into  existence. 

The  voucher  record  is  a  very  useful  book,  in  that  it 
discloses  the  amount  of  vouchers  payable  which  were  re- 
ceived from  all  sources  during  the  month  and  provides  for 
the  distribution  of  that  amount,  whether  to  the  classes 
of  materials  purchased,  or  to  the  individual  accounts 
raised  to  analyze  the  expenses  of  the  period;  it  can  even 
be  made  to  reflect  the  true  status  of  that  liability  at  any 
time  during  the  accounting  period,  as  well  as  the  sundry 
steps  which  have  been  taken  to  incur  it  and  to  reduce  it. 
The  book  is  undoubtedly  the  highest  expression  of  that 
power  of  analysis  with  which  books  of  original  entry  have 
been  credited.  But  there  is  a  limit  to  its  usefulness,  and 
to  claim  more  for  it  than  it  can  do,  is  to  mislead  the 
student  of  accounting  and  the  business  man. 


CHAPTER  X 

THE  TECHNIQUE  OF  POSTING 

Functions  of  the  Ledger 

Under  the  word  "Post"  the  Encyclopaedic  Dictionary 
gives  the  following:  "Bookkeeping:  (i)  To  carry  or 
transfer  (as  items,  accounts)  from  a  journal  to  a  ledger.  (2) 
To  make  the  necessary  or  proper  entries  in:  as,  To  post 
one's  books."  And  under  the  word  "postil"  it  says:  "An 
explanatory  or  marginal  note  *  *  *  especially  one  written 
in  a  margin;  a  commentary." 

The  above  definitions  show  that  items  appearing  in  a 
journal  (or  book  of  original  entry)  must  be  carried  to 
proper  accounts  in  the  ledger,  sufficient  marginal  notes, 
or  commentaries,  being  made  in  order  to  render  the  entry 
self-explanatory.  From  what  has  been  said  in  the  fore- 
going chapter  in  connection  with  the  ledger  account 
frame,  it  seems  that  the  proper  place  for  these  marginal 
notes,  or  commentaries,  is  the  space  allotted  to  the  date, 
the  explanation,  and  the  reference  to  the  journal  and 
journal  folio  from  which  the  entry  comes. 

If  the  ledger  is  used  with  due  respect  for  the  purpose 
for  which  it  was  created,  each  individual  account  affords 
invaluable  information  in  regard  to: 

1.  The  particular  value  referred  to  by  the  name 

2.  The  positive  and  negative  (Dr.  and  Cr.)  fluctua- 

tions of  the  value 

3.  The  counterpart  of  every  side  of  the  value  and  of 

every  item  on  each  side,  and,  in  certain  cases — 
121 


122 


THEORY    AND    TECHNIQUE    OF    ACCOUNTS 


4,  The  causes  which  have  brought  about  the  in- 
creases and  the  decreases 
If,  however,  the  information  which  the  frame  of  the 
account  provides  for,  is  omitted  or  is  carelessly  stated, 
the  ledger  loses  its  value,  and  becomes  a  mere  index  of 
the  monetary  importance  of  transactions,  and  of  their 
location  in  books  of  original  entry. 

Rules  for  Posting 

The  rules  which  accountants  would  like  adopted  in 
regard  to  ledger  explanations  are  as  follows: 

1.  When  debiting  or  crediting  an  account,  give  in 

the  space  allotted  to  explanations  the  name  of 
the  account  which  is  credited  or  debited  as  a 
result  of  the  transaction. 

2.  When  debiting  or  crediting  an  account  with  an 

amount  representing  credits  or  debits  to  sev- 
eral accounts,  insert  the  word  "Sundry"  in  the 
place  reserved  for  explanations. 

3.  Refer  clearly  to  the  journal  from  which  the  entry 

comes. 

The  meaning  of  a  ledger  account  kept  in  accordance 
with  the  above  rules,  is  readily  understood  by  the  layman, 
and  in  a  great  many  cases  the  surface  information  which 
the  book  affords  will  be  quite  sufficient  to  satisfy  the  re- 
quirements of  the  proprietor  of  the  business.  The  only  ac- 
counts which  he  needs  to  investigate  further,  if  detail  is 
required,  are  the  ones  containing  the  explanation  "Sun- 
dry." If,  on  the  other  hand,  the  ledger  shows  amounts 
only,  or  abbreviated  explanations  which  only  the  book- 
keeper can  understand,  it  is  of  no  value  to  the  proprietor. 
Bookkeepers  are  generally  interested  only  in  methods  and 
devices  which  save  them  personal  effort;  they  are  apt  to 
forget  that  they  were  not  engaged  to  make  their  work 


THE    TECHNIQUE    OF    POSTING 


123 


easy,  but  to  keep  books  in  such  a  manner  as  to  make  them 
valuable  to  the  employer. 

In  this  connection,  it  must  be  said  that  bookkeepers 
who  do  not  respect  well-established  principles  of  book- 
keeping because  they  are  personally  unable  to  see  the 
basis  on  which  they  rest,  have  robbed  the  double-entry 
method  of  a  great  deal  which  was  valuable,  and  are  re- 
sponsible for  the  lack  of  illuminative  information  which  so 
many  modern  books  reveal  upon  close  investigation. 


CHAPTER  XI 

CONTROLLING  ACCOUNTS 

General  and  Subsidiary  Ledgers 

Inasmuch  as  the  establishment  of  ledger  controls  has 
resulted  from  the  evolution  of  the  journal,  and  for  the 
further  reason  that  the  whole  theory  of  controlling  ac- 
counts rests  more  upon  a  question  of  mechanism  of 
books  than  upon  a  question  of  principles,  it  may  be  well 
to  make  the  controlling  accounts  serve  as  a  connecting 
link  between  the  theory  of  the  books  and  the  general 
classification  of  the  accounts  which  the  books  contain. 

Ledgers  are  frequently  referred  to  as  "general"  and 
"subsidiary"  (or  "underlying").  The  word  general,  when 
applied  to  a  ledger,  means  that  the  book  contains  one  ac- 
count with  every  value,  whether  positive  or  negative, 
which  is  part  of  the  business  as  a  whole.  If,  then,  sub- 
sidiary ledgers  are  used,  it  must  be  that  some  of  the  gen- 
eral ledger  accounts  require  to  be  kept  more  minutely 
than  can  conveniently  be  done  in  the  general  book.  In 
large  concerns,  for  instance,  there  is  sometimes  kept  a  real 
estate  ledger  in  which  every  parcel  of  land  and  every 
building  held  for  investment  is  given  an  account  of  its 
own,  while  the  aggregate  amount  of  the  property  then 
held  is  carried  in  the  general  ledger.  The  same  thing  may 
be  done  in  connection  with  bonds  and  stocks  of  other 
companies,  machinery  and  tools,  materials  and  supplies, 
and,  generally  speaking,  with  any  account  involving  a 
variety    of    detail.      Therefore,    the    term    "Controlling 

124 


CONTROLLING    ACCOUNTS  I25 

Account,"  which  is  given  to  ledger  accounts  recording 
the  aggregate  of  transactions  the  detail  of  which  is  kept 
in  other  books,  applies  to  a  multitude  of  cases.  More 
commonly,  however,  the  term  "controlling"  is  associated 
with  accounts  which  show  the  extent  of  the  transactions 
with  customers  and  creditors,  as  shown  in  detail  by  the 
subsidiary  ledgers. 

Genesis  of  the  Controlling  Account 

It  will  be  readily  admitted  that  even  before  the 
journal  was  divided  into  its  integral  parts,  it  was  possible, 
for  balance  sheet  purposes,  to  obtain  the  net  amount  due 
from  customers,  even  though  the  general  ledger  was  not 
entirely  posted,  or  was  out  of  balance.  An  analysis  of  the 
journal,  if  accurately  made,  would  give  the  sales,  the  re- 
turned sales,  and  allowances,  as  well  as  the  settlements 
made  by  customers  and  the  losses  of  discounts  which  they 
involved.  But  the  process  was  lengthy,  and  the  delay 
might  prove  irksome  to  the  administrative  body,  whose 
demand  for  accurate  and  timely  information  concerning 
financial  facts  was  growing  apace  with  the  development  of 
the  business. 

The  analytical  results  given  by  the  books  of  original 
entry  which  were  subsequently  built  up  from  the  journal 
root,  made  it  possible  to  obtain,  not  only  the  minutest 
detail  of  every  transaction,  but,  as  well,  periodical  totals 
of  broad  classes  of  facts.  This  pointed  the  way  towards 
the  partial  reconstruction  of  the  general  ledger.  Every- 
thing which  compelled  the  handling  of  a  mass  of  detail 
and  retarded  the  obtaining  of  financial  statements,  was 
taken  bodily  out  of  the  general  ledger  and  transferred  to 
subsidiary  books  where  it  could  be  conveniently  handled 
by  clerks  less  skilled  in  the  science  of  accounts  than  the 
general  bookkeeper.  To  the  latter  was  assigned  the  task 
of  controlling  the  work  of  his  subordinates.    He  gathered 


126      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

his  facts  monthly  from  the  books  of  original  entry;  hence, 
if  he  were  certain  of  the  arithmetical  accuracy  of  the  data 
reflected  by  the  said  books,  he  could  not  only  arrange  his 
material  quickly  for  statement  purposes,  but  could  estab- 
lish as  well  the  aggregate  amount  of  the  individual  ac- 
counts, the  detail  of  which  was  to  be  shown  later  by  the 
lists  of  balances  taken  from  the  subsidiary  ledgers.  Nor  did 
it  matter,  as  far  as  financial  status  was  concerned,  whether 
or  not  the  subsidiary  books  agreed  with  his  controls.  The 
statements  were  made  at  all  events,  and  known  to  be  correct, 
since  the  general  ledger  was  in  balance. 

Theory  of  the  Controlling  Account 

Thus  it  was,  that  the  controlHng  accounts  came  into 
existence.  Basing  our  definition  of  them  upon  their 
origin,  we  might  say:  The  term  "controlling"  applies  to 
ledger  accounts  which,  by  means  of  the  periodical  record- 
ing of  the  aggregates  of  debit  and  credit  transactions 
shown  by  books  of  original  entry,  measure  the  per- 
iodical status  of  certain  broad  classes  of  financial  facts 
and,  at  the  same  time,  control  their  detail  posting  in  sub- 
sidiary books. 

The  process  of  transferring  to  subsidiary  books,  ac- 
counts which  are  to  be  controlled  by,  instead  of  being 
kept  in,  the  general  ledger,  does  not  involve  any  unusual 
knowledge  of  accounting  principles;  still,  the  type  of 
journal  entries  necessary  to  create  controlling  accounts 
for  customers  and  creditors,  and,  more  generally,  all 
journal  entries  which  necessitate  a  posting  to  the  general 
ledger  and  another  posting  to  underlying  ledgers,  are 
confusing  to  the  student  of  accounting;  they  appear  to 
him  to  be  three-sided,  and  destructive  of  that  equilibrium 
on  which,  as  he  has  been  told,  the  whole  system  of  double 
entry  rests.  Take  the  case  of  a  journal  entry  creating  a 
customers'  controlling  account,  for  instance: 


CONTROLLING    ACCOUNTS 

References 
Names  and  Explanation  /-  t     ^  t  Dr.  Cr. 


127 


Customers'  Controlling  Account 25        $3,000.00 

A     (Name  of  Customer) i        75  $   soo.oo 

B  "  2        80  150.00 

C  "  3       85  100.00 

D  "  4        89  7500 

E  "  5        91  925.00 

F  "  6       97  1,250.00 

To  close,  in  the  general  ledger,  the 

individual     accounts    of    the    above 

customers,  and  transfer  the  aggregate 

to  the  controlling  account.     The  in- 
dividual accounts  are   to  be  carried 

in  a  subsidiary  ledger  to  be  known  as 

customers  ledger. 

The  journal  provides  for  a  debit  to  the  controlHng  ac- 
count, and  a  credit  to  each  individual  account  to  be 
closed;  this,  in  effect,  means  that  the  equilibrium  having 
been  disturbed  by  the  debit,  is  reestablished  by  the  credit; 
but  another  debit  to  each  individual  customer's  account 
must  be  made  in  the  underlying  ledger  to  open  the  in- 
dividual accounts.  The  student  is  unable  to  find  a  bal- 
ancing credit  therefor,  and  begins  to  believe  that  the 
whole  theory  is  erroneous.  A  few  words  of  explanation 
may  serve  to  dispel  such  doubts,  as  well  as  to  review  some 
of  the  principles  expressed  in  the  preceding  chapters. 

All  financial  books  are  either  journals  or  ledgers;  the 
journal  may  be  kept  in  its  entirety,  or  it  may  be  cut  up 
into  its  component  parts,  but  whether  found  under  one 
form  or  the  other,  it  is  nevertheless  the  journal,  and  its 
nature  and  its  importance  do  not  change.  The  ledger 
may  also  be  cut  up  in  as  many  parts  as  may  best  be 
adapted  to  the  requirements  of  the  business;  for  instance, 
there  might  be  a  section  for  impersonal  assets,  another  for 
impersonal  liabilities  and  capital,  a  third  for  nominal  ac- 
counts, and  a  fourth  for  personal  accounts  of  customers 


128      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

and  creditors;  one-half  of  this  last  section  being  personal 
assets,  the  other  half  being  personal  liabilities.  To  illus- 
trate: 


General  Ledger  in  Four  Sections 


Impersonal 

Impersonal  Li- 

Nominal    A  c  - 

a.  Personal  Ac- 

Assets 

abilities  &  Cap- 

counts,    Debits 

counts  —  Cus- 

ital 

and  Credits 

tomers' 

b.  Personal  Ac- 
counts —  Cred- 
itors' 

I. 

2. 

3- 

4- 

This  would  not  make  parts  2,  3,  or  4,  subsidiary 
ledgers;  it  would  merely  make  them  units  of  the  whole. 
But  if  we  were  to  add  the  balances  shown  by  the  individ- 
ual accounts  in  part  "a"  of  section  4,  and  enter  the  total  thus 
obtained,  among  the  assets  found  in  section  i ;  if,  further, 
we  were  to  do  the  same  thing  with  the  accounts  found  in 
part  "b"  of  section  4,  and  embody  the  amount  in  section  2, 
we  would  have: 


General  Ledger 

Subsidiary 
Ledger 

Impersonal  As- 
sets   and    Con- 
trol of  Personal 
Assets 

Impersonal  Li- 
abilities,   Capi- 
tal and  Control 
of  Personal  Li- 
abilities 

Nominal 
Accounts 

a.  Personal 
Accounts — 
Customers' 

b.  Personal  Ac- 
counts —  Cred- 
itors' 

I. 

2. 

3. 

Thus,  we  would  find  in  section  i  an  account  con- 
trolling part  "a"  of  the  subsidiary  ledger,  and  in  section  2  an 
account  controlling  part  "b"  of  the  subsidiary  ledger. 


CONTROLLING    ACCOUNTS  129 

It  becomes  plain  that  (since  the  journal  establishes 
and  maintains  the  equilibrium  between  the  positive  and 
negative  values  found  in  the  general  ledger),  when  we 
say  that  two  postings  must  be  made  of  every  debit  and  of 
every  credit  entry  affecting  the  controlling  account  of  the 
customers  or  of  the  creditors,  we  mean  that  one  of  the 
postings  is  necessary  to  show  that  the  equilibrium  has 
been  disturbed  and  reestablished,  owing  to  the  occurrence 
of  certain  transactions,  and  that  the  other  posting  is 
merely  in  the  nature  of  a  memorandum,  involving  no  prin- 
ciple of  any  kind,  and  intended  merely  to  contribute  to 
the  gathering  of  facts  which,  in  the  aggregate,  will  sup- 
port other  facts  expressed  elsewhere  in  concrete  form. 

Self-Balancing  Ledger 

One  of  the  indirect  applications  of  the  controlling  ac- 
counts is  found  in  what  is  sometimes  qualified  as  a  "self- 
balancing  ledger."  Taking  the  customers  ledger  as  an 
instance,  the  bookkeeper  operating  a  self-balancing  ledger 
of  the  customers'  accounts,  is  supposed  to  post  daily  the 
details  of  the  transactions  affecting  them  individually,  and 
when  this  is  accomplished,  to  post  the  total  of  the  said 
transactions  into  a  "control"  to  which  a  special  place  is 
given,  either  at  the  beginning  or  at  the  end  of  the  book. 
It  goes  without  saying  that  the  data  which  constitute  the 
"control"  posting,  are  supposed  to  be  taken  independ- 
ently of  the  detail.  Monthly,  or  oftener,  the  bookkeeper 
is  in  a  position  to  control  his  own  work,  since  the  special 
account  gives  him  the  aggregate  amount  which  the  open 
balances  of  the  individual  accounts  must  reflect  and 
support. 

It  must  be  remarked,  in  connection  with  the  self- 
balancing  ledgers,  that  if  the  subsidiary  "controls"  are 
really  what  they  claim  to  be,  they  reduce  the  general 
ledger  accounts  which  usually  operate  in  the  capacity  of 


J30      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

controllers,  to  the  rank  of  aggregate  asset  or  liability  ac- 
counts, that  is  to  say,  mere  memorandum  accounts. 

The  accounts  which  the  private  ledger  and  the  gen- 
eral ledger  keep  one  with  the  other,  are  sometimes  quali- 
fied as  "controlling."  The  same  is  true  of  the  general 
ledger  and  of  the  income  ledger.  This,  however,  is  con- 
trary to  principles.  We  have  seen  that  the  effect  of  a 
controlling  account  is  to  eliminate  from  the  general 
ledger  the  detail  of  what  was  originally  a  part  of  that 
book,  and  that  the  part  thus  removed  becomes  a  sub- 
sidiary unit  of  the  accounting  scheme.  Few  accountants 
would  be  willing  to  say  that  the  general  ledger  is  a  sub- 
sidiary of  the  private  ledger  because  the  latter  contains  a 
controlling  account  with  the  former,  and  that,  for  the 
same  reason,  the  private  ledger  is  a  subsidiary  book  of  the 
general  ledger.  In  reality,  the  accounts  which  one  sec- 
tion of  the  ledger  contains  with  other  sections  of  the  same 
book  are  not  controlling  accounts,  but  balance  accounts, 
precisely  as  the  would-be  "control"  of  the  self-balancing 
subsidiary  ledger  is  only  a  balance  account. 


CHAPTER  XII 

CLASSIFICATION  OF  ACCOUNTS 

General  ClassiRcation 

For  purposes  of  general  classification  on  the  basis  of 
financial  status  and  earning  capacity,  accounts  are  classi- 
fied as: 

^     ,    .  (  Personal  Accounts 

1.  Real  Accounts    •<  ,  ,    . 

(  Impersonal  Accounts 

r  Fictitious,    Economic,    Loss 

2.  Nominal  Accounts  •<  and     Gain,     Representative 

(  Accounts 

3.  Accounts  Partially  Real  and  Partially  Nominal 

I.     Real  Accounts 

Accounts  are  said  to  be  real  when  they  represent 
positive  or  negative  elements  of  invested  values,  the  net 
amount  of  which  measures  the  equity  of  the  proprietor  in 
positive  values.  In  other  words,  the  real  accounts  are  all 
the  assets  and  the  true  liabilities,  the  latter  term  excluding 
accounts  expressing  proprietorship,  accounts  of  sole  traders, 
and  accounts  of  copartnerships.  Liabilities  resulting  from, 
or  incident  to,  the  issue  of  capital  stock,  are  real  liabilities, 
as  will  be  seen  later,  when  speaking  of  capital  stock. 

Real  accounts  are  subdivided  into  personal  and  im- 
personal. The  personal  accounts  include  all  the  accounts 
with  persons,  whether  such  persons  have  an  individual  ac- 
count in  the  general  ledger,  or  whether  the  aggregate  of 
their  accounts  is  reflected  by  a  controlHng  account.  The 
term  **impersonar'  applies  to  all  other  real  accounts. 

131 


132 


THEORY    AND    TECHNIQUE    OF    ACCOUNTS 


2.     Nominal  Accounts 

The  term  "nominal"  applies  to  all  accounts  opened 
during  the  accounting  period  to  record  the  causes  for 
such  fluctuations  of  real  accounts  as  have  resulted  in  an 
operating  loss  or  gain,  an  expense,  an  addition  to,  or  a 
deduction  from,  income.  They  are  called  nominal  be- 
cause, in  so  far  as  inventorial  value  is  concerned,  they 
exist  in  name  only.  Cash,  buildings,  land,  are  called  real, 
because  they  exist  in  some  tangible  form;  good-will  is 
called  real,  because,  although  intangible,  it  has  or  is  sup- 
posed to  have  a  salable  value;  interest  (received  or  paid 
otherwise  than  in  advance)  is  called  nominal,  because  it 
represents  no  inventorial  value,  tangible  or  intangible, 
positive  or  negative.  Interest  merely  gives  the  result  of 
a  series  of  transactions  the  effect  of  which  has  been  to 
bring  about  the  income  or  the  outgo  of  a  value  (cash  or 
claim)  in  exchange  for  financial  assistance  given  or 
received. 

The  term  "fictitious"  which  is  sometimes  applied  to 
nominal  accounts  is  objected  to  by  many  accountants, 
because  of  the  generally  accepted  meanings  of  the  word, 
i.e.,  imaginary,  false,  not  genuine,  fabulous,  etc.  It  is 
not  easy  to  see  how  misleading  accounting  terminology 
can  in  any  way  make  clear'  to  the  student  the  principle 
underlying  the  nominal  accounts. 

The  term  "economic  accounts"  is  also  given  to  nom- 
inal accounts.  The  word  economic  means:  pertaining  to 
the  management  of  the  household,  the  state,  the  nation, 
the  business,  etc.  And  as  it  is  through  management  that 
gains  are  made,  losses  sustained,  and  expenses  incurred, 
it  follows  that  every  account  recording  such  occurrences 
may  rightly  be  termed  economic. 

The  expression  "loss  and  gain  accounts"  is  open  to  the 
objection  that  it  tends  to  obscure  principles  by  convey- 
ing the  idea  that  expenses  are  losses.    "Salaries,"  for  ex- 


CLASSIFICATION    OF    ACCOUNTS 


133 


ample,  which  some  textbooks  call  a  loss  and  gain  ac- 
count, is  not  a  loss,  but  an  expense  necessary  to  obtain 
for  the  business  the  benefit  of  the  services  which  it  re- 
quires. To  call  expenses  losses,  is  to  ignore  one  of  the 
main  purposes  of  accounting,  which  is  to  dififerentiate  be- 
tween them. 

The  word  "representative"  is  also  sometimes  used  in 
connection  with  the  accounts  which  show  causes.  It  is 
said  of  them,  to  explain  the  use  of  the  term,  that  they 
"represent"  the  particular  subject  matter  which  their 
name  indicates.  Thus,  rent  is  called  a  representative  ac- 
count, because  it  represents  the  transactions  relating  to 
rent, 

3.     Accounts  Partially  Real  and  Partially  Nominal 

The  assets  of  a  concern  may  be  said  to  be  invested,  or 
acquired : 

1.  To  remain  permanently  invested  in  the  business 

and  serve  as  a  basis  for  operations 

2.  To  be  used  as  current  resources,  that  is  to  say, 

as  financing  media 

3.  To  be  sold  at  a  profit,  either  in  the  very  form  in 

which  they  were  invested  or  acquired,  or  after 
they  have  been  subjected  to  a  process  altering 
their  nature 

4.  To   be   consumed   pending   operations,   for   the 

benefit  of  the  business  as  a  whole 

Groups  I  and  2  are  real  values  at  all  times,  and  the 
fluctuations  to  which  they  are  subject  are  accounted  for 
by  nominal  accounts  in  all  cases  where  the  fluctuations 
have  resulted  in  increases  or  decreases. 

Group  3  contains  elements  which,  under  certain 
methods  of  accounting,  may  be  partially  real  and  partially 
nominal.    If,  for  instance,  a  merchandise  account  is  kept, 


134     THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

it  contains  a  real  element  the  value  of  which  is  ascertained 
only  at  inventory  times,  and  a  nominal  element  the  ex- 
tent of  which  is  known  as  soon  as  the  real  element  is  ob- 
tained.   Of  this,  more  will  be  said  later. 

As  to  group  4,  if  the  items  which  it  contains  are 
shown  by  inventory  to  have  been  consumed  entirely,  the 
accounts  representing  them  have  ceased  to  be  partially 
real,  and  have  become  essentially  nominal.  If  they  are 
shown  not  to  have  been  entirely  consumed,  their  inven- 
torial  value  is  real,  the  consumed  proportion  is  nominal, 
and  the  accounts  must  be  relieved  of  either  the  real  or  the 
nominal  elements,  as  will  be  shown  subsequently. 

Asset  and  Liability  Classification 

For  purposes  of  recording  and  expressing  the  finan- 
cial status  of  a  business,  accounts  are  classified  as: 

1.  Asset  Accounts,  including: 

All  real  values  actually  possessed,  or  earned  and 
receivable,  as  well  as  all  prepayments  ap- 
plicable to  periods  subsequent  to  any  par- 
ticular period 

2.  Liability  Accounts,  including: 

a.     For  Corporations : 

(i)     The  liabilities  to  outsiders 
(2)     The  liability  of  the  artificial  being 
"The  Corporation"  to  the  stock- 
holders, at  time  of  dissolution,  for: 

(a)  The  outstanding  capital  stock 

(b)  All  the  surplus  earnings  not 

declared  in  dividends 

(c)  The  income  and  the  benefits 

held  out  of  surplus,  for  ap- 
plication to  the  profits  of 
subsequent  periods 

(d)  Unapplied  reserves 


CLASSIFICATION    OF    ACCOUNTS  135 

b.     For    Sole    Proprietorships   and   Copartner- 
ships: 

( 1 )  The  liabilities  to  outsiders 

(2)  The  proprietorship  accounts,  repre- 

sented by : 

(a)  Capital  accounts 

(b)  Undrawn,  undistributed,  or 

unapplied  profits 

(c)  All  credit  accounts  which  do 

not  constitute  liabilities  to 
outsiders,  whether  re- 
serves  unapplied   or   per- 
sonal credit  accounts 
Assets  and  Asset  Accounts 

The  word  "asset"  comes  from  the  French  word  "assez" 
or  from  the  Provencal  "assats,"  both  meaning  "enough" 
or  "sufficient."  Commenting  upon  assets,  Blackstone 
says  that  "the  term  receives  its  name  because  its  posses- 
sion is  sufficient  to  render  the  executor  or  administrator 
liable  to  discharge  the  debts  and  legacies  of  the  deceased 
person,  so  far  as  the  assets  may  be  sufficient  for  the  pur- 
pose." 

The  report  of  the  special  committee  of  the  American 
Association  of  Public  Accountants,  on  accounting  terminol- 
ogy, defines  assets :  "Property,  fixed  or  liquid ;  resources 
of  any  kind  capable  of  being  converted  into  money  or  value. 
The  term  is  used  sometimes  as  applying  to  good-will, 
concessions,  franchises,  deferred  charges,  and  in  English 
accounting  even  to  preliminary  expenses  incurred  in  the 
formation  of  a  company."  Greendlinger's  "Accounting 
Practice"  states  broadly  that  "any  part  of  a  man's  property 
or  business  that  may  be  used  for  the  extinction  of  his  debts 
is  called  assets."  Bentley's  "Science  of  Accounts"  speaks 
of  assets  in  these  terms :  "The  assets  of  a  business  are 
anything  of  value  belonging  to  it,  such  as  real  estate,  ma- 


136      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

chinery,  horses  and  wagons,  office  furniture,  book  debts, 
notes  receivable,  merchandise  on  hand,  insurance  premiums 
paid  in  advance,  etc." 

The  accounting  meaning  of  the  word  "assets"  does  not 
appear  capable  of  being  reduced  to  general  definitions  like 
the  above,  for  values  may  be  assets  under  certain  condi- 
tions and  not  under  others;  nor  is  it  necessary  that  a  value 
"may  be  used  for  the  extinction  of  a  man's  debts"  in  order 
that  it  may  be  raised  to  the  dignity  of  an  asset.  Sta- 
tionery and  printed  matter,  for  instance,  are  often  referred 
to  as  assets  of  a  going  concern;  still  they  might  have  no 
value  available  for  the  liquidation  of  any  of  the  debts  of 
the  business.  It  seems,  then,  that  the  definition  of  assets 
might  be  extended  to  cover  their  peculiarities.  The  term 
"assets,"  when  this  is  done,  means : 

1.  For  a  going  concern: 

That  which  is  owned  and  invested  in  the  busi- 
ness; that  which  is  earned,  although  not 
received,  and  constitutes  a  collectable  claim; 
that  which  has  been  expended  for  the  bene- 
fit of  future  periods 

2.  For  a  concern  about  to  liquidate: 

a.  If  the  concern  enjoys  the  benefit  of  limited 

liability: 

That  which  is  owned,  invested  in  the 
business,  and  convertible  into  re- 
sources applicable  to  the  liquida- 
tion of  the  liabilities  of  the  concern 

b.  If  the  concern  does  not  enjoy  the  benefit  of 

limited  liability: 

That  which  the  proprietors  of  the  busi- 
ness own  and  is  not  exempt  by  law 
from  being  seized  and  converted 
into  resources  applicable  to  the 
liquidation  of  their  liabilities. 


CLASSIFICATION    OF    ACCOUNTS  137 

Asset  accounts  are  the  accounts  in  which  are  recorded 
the  initial  value  of  assets,  and  all  subsequent  transactions 
affecting  them. 

Liabilities  and  Liability  Accounts 

There  is  perhaps  no  term  used  in  accounting  which 
has  caused  so  much  discussion  as  the  word  liability.  Ac- 
cording to  the  revised  edition  of  the  Encyclopaedic  Dic- 
tionary, liability  means:  "The  quality  or  state  of  being 
liable,  responsible,  or  bound  in  law  or  justice.  That  for 
which  one  is  liable;  specifically  the  debts  or  pecuniary  en- 
gagements for  which  one  is  liable."  The  report  on  ac- 
counting terminology  which  has  been  mentioned  in  con- 
nection with  assets,  says  that  "liabilities  embrace  all  the 
debts  or  obligations  due  by  the  firm  to  its  creditors,  or  the 
debts  and  obligations  of  a  corporation,  partnership  or  in- 
dividual." Lisle  says  that  "the  liabiHties  of  a  business 
consist  of  all  the  sums  due  to  outside  creditors,  as  distin- 
guished from  the  sums  due  to  partners  or  stockholders." 

The  foregoing  definitions  do  not  appear  to  take  into 
consideration  the  manifold  phases  of  liabilities;  they  seem 
to  ignore  the  ever-present  possibility  of  accountabilities 
becoming  liabilities  as  a  direct  result  of  the  materializa- 
tion of  contingencies. 

The  liabilities  of  a  going  concern  may  be  said  to  be: 

1.  Those  which  are  past  due. 

2.  Those  which  are  due,  but  not  as  yet  payable,  in 

consequence  of  the  terms  of  credit  extended. 

3.  Those  for  which  indebtedness  has  been  incurred, 

but   which  are,   at   present,   neither  due  nor 
payable. 

4.  Those   for   which    the   possibility    of   becoming 

liable    depends    upon    contingencies    of    the 
future. 


138      THEORY    AND    TECHNIQUE    OF    ACCOUNTS 

On  the  other  hand,  the  word  liabilities  might  be  made 
to  apply,  for  a  concern  enjoying  limited  liability,  and 
about  to  liquidate,  to: 

1.  Those  which  are  due,  about  to  become  due,  or 

certain  to  become  due  as  a  direct  result  of 
operations,  and  payable  out  of  the  proceeds 
of  the  sale  of  invested  assets. 

2.  Those  which  will  become  due  if  certain  contin- 

gencies materialize. 

3.  The  remainder  of  the  assets  (if  any)  after  liquida- 

tion of  all  liabilities  to  outsiders,  which  the 
proprietors  will  withdraw  from  the  enterprise, 
or  which  the  corporation  in  its  capacity  as  an 
artificial  being  about  to  lose  its  legal  entity, 
owes  to  the  stockholders. 

Lastly,  the  liabilities  of  a  concern  not  enjoying  the 
privilege  of  limited  liability  and  about  to  liquidate,  might 
be  said  to  be: 

Those  which  are  due,  about  to  become  due  or  certain 
to  become  due  upon  the  materialization  of  con- 
tingencies, and  are  payable  out  of  the  proceeds  of 
the  sale  of  any  value  owned  by  the  members  of  the 
concern  which  is  not  exempted  by  law  from 
seizure,  whether  or  not  it  is  invested  in  the  busi- 
ness. 

.  Liability  accounts  are  so  named  because  they  record 
the  original  amount  of  the  liabilities,  and  all  subsequent 
transactions  in  regard  thereto. 


Part  III — The  Theory  of  the  Asset  Accounts 


CHAPTER  XIII 

CASH  ACCOUNT— PETTY  CASH 

The  Theory  of  the  Cash  Account 

Under  the  tenets  of  the  personalistic  theory  of  ac- 
counts the  cash  account  is,  in  principle,  an  account  with 
the  cashier.  Without  going  into  the  merits  of  that 
theory,  it  may  be  said  to  have  the  advantage  of  restricting 
the  treatment  of  cash  to  the  recording  of  actual  receipts 
and  disbursements.  This  may  sound  like  a  truism,  and 
it  will  no  doubt  be  advanced  that  the  same  restrictions 
apply,  no  matter  under  what  theory  the  cash  account  is 
kept.  Still,  every  accountant  knows  that  a  great  many 
ledger  accounts  with  cash  contain  items  which  are  called 
receipts  merely  because  they  have  not  been  disbursed,  and 
items  which  are  called  disbursements  merely  because  they 
have  not  been  received.  It  is  because  this  latter  treat- 
ment is  not  generally  thought  to  be  wrong,  that  so  many 
students  of  accounting  find  great  difficulty  in  solving 
practical  problems  which  present  the  cash  account  of  a 
trustee,  without  stating  as  receipts  the  proceeds  of  the 
securities  held  for  creditors  and  sold  for  them  under  the 
indenture  of  the  pledge,  and  as  disbursements  the  reduc- 
tion or  the  liquidation  of  fully  or  partially  secured  liabili- 

139 


I40      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

ties.  It  is  also  because  the  average  bookkeeper  does  not 
clearly  understand  the  purpose  of  the  cash  account  that 
so  many  entries  are  made  which  deprive  the  books  of  a 
concern  of  that  harmonious  relation  which  should  exist 
between  them  and  the  books  of  all  other  concerns  with 
which  business  relations  have  existed.  Let  us  illustrate  the 
cash  account  by  the  following  example : 

A  owes  Bank  B  $50,000,  representing  a  time  loan  se- 
cured by  600  shares  of  stock,  of  par  value  of  $100  each, 
which  A  carries  on  his  books  at  $59,500.  A  being  unable 
to  meet  the  loan  at  maturity,  the  bank  sells  the  securities 
for  $57,000,  deducts  from  the  proceeds  the  principal  of  the 
loan,  plus  $1,500  of  interest  due  under  the  loan,  and 
credits  A  with  the  balance,  i.e.,  $5,500. 

If  we  were  to  examine  the  books  of  Bank  B  we  would 
find,  as  a  result  of  the  foregoing: 

Cash debited  with  $57,000.00 

Loans  Receiv- 
able   credited  with  $50,000.00 

Accrued  Interest 

on  Loans. ...  credited  with  1,500.00 

A credited  with  5,500.00 

If,  on  the  other  hand,  we  were  to  examine  A's  books, 
it  is  not  improbable  that  we  would  find: 

Cash debited  with  $57,000 

Investments credited  with  $57,000 

Cash   credited  with  51,500 

Loans  Payable debited  with     50,000 

Interest  Accrued  on 

Loans debited  with       1,500 

Investments credited  with  2,500 

Profit  and  Loss debited  with       2,500 


CASH  ACCOUNT— PETTY  CASH 


141 


Whereas,  if  proper  respect  had  been  paid  to  the  pur- 
pose of  bookkeeping  and  to  the  principles  underlying  the 
double-entry  system,  we  should  have  found  on  A's  books: 

Cash debited  with  $5,500 

Interest  Accrued  on 

Loans debited  with     1,500 

Loans   Payable debited  with  50,000 

Profit  and  Loss debited  with     2,500 

Investments   credited  with: 

Cash  $5,500 

Sundry  54,ooo 

This  latter  handling  of  the  facts  would  make  A's  books 
harmonize  perfectly  with  the  books  of  the  bank,  in  so  far 
as  the  loan  transaction  is  concerned,  and  besides  would 
have  the  advantage  of  applying  the  following  principle: 

The  outgo  of  a  positive  value  (investments)  has  been 
counterbalanced  by : 

1.  The  income  of  a  positive  value  (cash) 

2.  The  outgo  (liquidation)  of  two  negative  values: 

a.  Loan  principal 

b.  Loan  interest 

3.  A  loss  sustained  through  the  sale  of  a  ledger  asset 

The  first  set  of  entries  makes  it  appear  that  the  bank 
has  paid  A  $57,000;  that  A  has  paid  back  to  the  bank 
$51,500;  that  because  the  bank  has  paid  A  only  $57,000, 
A  has  suffered  a  loss  of  $2,500,  since  his  property,  which 
the  bank  held,  was  worth  $59,500.  What  makes  matters 
worse,  is  that  A's  ledger,  being  posted  from  his  cash  book, 
shows  that  loans  payable  and  interest  accrued  on  loans 
were  repaid  in  cash.  If  we  had  taken  an  abstract  of  A's 
ledger  for  audit  purposes,  and  we  were  attempting  to  find 
documentary  evidence  of  the  individual  transactions  sup- 
porting the  totals  shown  by  the  abstract,  we  would  look 


142      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

in  vain  for  evidences  of  the  above  disbursements.  Nor 
could  we  find  anywhere  in  the  statements  furnished  by  the 
bank  a  credit  to  A  of  $57,000.  Reverting  to  the  ledger 
account  with  cash,  we  would  find  that  while  the  initial 
and  closing  balances  are  correct,  the  intervening  facts  on 
both  sides  are  misleading  in  so  far  as  they  do  not  reflect 
what  took  place. 

In  view  of  the  foregoing,  it  may  be  said  that  the  theory 
of  the  cash  account  demands  that  it  shall  be  made  to  re- 
flect actual,  not  theoretical,  receipts  and  disbursements, 
and  a  balance  resulting  from  actual  positive  and  negative 
facts,  which  can  be  readily  proved  and  supported.  To 
make  this  possible,  the  cash  journal  must  be  used  strictly 
as  the  scales  in  which  the  cash  transactions  are  to  be 
weighed  as  they  occur,  and  not  as  they  might  occur. 

The  Cash  Account  and  the  Cash  Balance 

One  of  the  disadvantages  of  the  cash  account  as  it  is 
usually  kept,  no  matter  whether  or  not  the  foregoing 
principles  are  applied,  is  that  under  the  generally  estab- 
lished method  of  crediting  cash  when  a  check  is  drawn 
instead  of  when  it  is  paid  by  the  bank,  the  ledger  account 
with  cash  may  not  represent  the  actual  amount  of  cash  in 
bank.  To  some  accountants  this  spells  misrepresentation 
of  the  facts.  They  claim  that  a  check  being  an  order  to 
the  bank  to  pay  cash,  the  financial  status  of  the  enter- 
prise has  not  changed  until  the  payee  under  the  order  has 
presented  it  to  the  bank,  and  has  actually  received  pay- 
ment. This,  of  course,  means  that  since  the  check  was 
issued  to  Hquidate  a  liability,  the  liquidation  has  not  taken 
place,  and  the  liability  exists  until  the  check  is  paid.  Go- 
ing still  further,  they  say  that  if  on  December  31  the  books 
of  A  show  that  he  has  paid  B  $50,  while  the  books  of  B 
say  that  A  still  owes  him  $50,  one  set  of  books  does  not 
state  the  truth  at  December  31. 


CASH  ACCOUNT— PETTY  CASH 


143 


We  may,  with  all  propriety,  decline  to  allow  a  love 
for  logic  to  lead  us  so  far  from  the  domain  of  actuality. 
Still  we  must,  in  all  justice,  present  the  favorite  argu- 
ments of  all  schools.  It  has  been  said  that  a  cash  account 
which  does  not  show  the  true  balance  held  by  the  de- 
positories to  the  credit  of  a  concern  is  useless  in  checking 
the  accuracy  of  the  interest  credited  by  a  trust  company, 
say,  on  daily  balances. 

A  Correct  Cash  Account 

This  is  not  the  place  for  a  discussion  of  the  merits  of 
the  foregoing  claims,  but  it  is  the  place  for  the  presenta- 
tion of  a  very  interesting  handling  of  the  account  with 
cash,  which  some  railroads,  and  at  least  one  of  the  largest 
life  insurance  companies,  have  adopted,  either  substanti- 
ally as  given  in  the  following  or  with  slight  alterations. 
The  method  may,  or  may  not,  be  the  result  of  the  belief  of 
its  originators  in  the-  accounting  fallacy  of  the  one  which 
it  replaces,  but,  strangely  enough,  it  is  not  subject  to  any 
of  the  criticisms  which  have  been  made  of  its  rival.  Its 
proper  operation  requires,  besides  the  keeping  of  the  usual 
financial  books: 

1.  That  all  expenses  incurred  and  all  payments  to  be 

made  be  entered  in  a  voucher  record  (or  a  series 
of  records  assigned  to  typical  classes  of  ex- 
penses). 

2.  The  keeping  of  as  many  check  registers  as  there 

are  depositories. 

3.  A  ledger  account  with  audited  vouchers  unpaid. 

4.  A  treasurer's  memorandum  book  intended  to  show 

daily  the  available  balance  of  cash  subject  to 
check. 

It  presupposes  an  arrangement  whereby  the  depos- 
itories will  agfree  to  return  daily  the  canceled  checks.    Thi§ 


144 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


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CASH  ACCOUNT— PETTY  CASH 


145 


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fI46     THE    THEORY    OF    THE    ASSET    ACCOUNTS 


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CASH  ACCOUNT— PETTY  CASH 


147 


vital  prerequisite  of  the  method  is  sufficient  to  make  it 
impracticable  to  the  average  concern. 

As  to  its  technique: 

The  checks  drawn  are  recorded  daily  in  the  proper 
check  register,  and  the  amount  drawn  is  recorded  by  the 
treasurer  in  his  memorandum  book  of  available  cash.  The 
check  registers  provide  for  the  insertion  of  the  numbers 
of  the  vouchers  for  which  checks  are  drawn,  as  well  as  for 
any  other  information  which  may  facilitate  checking  from 
book  to  book. 

The  amount  of  canceled  checks  returned  by  the  banks 
is  posted  daily  in  the  cash  book  to  the  credit  of  cash,  and 
to  the  debit  of  audited  vouchers  unpaid.  The  returned 
checks  are  also  recorded  in  the  check  register  and  in  the 
voucher  record. 

At  the  end  of  a  given  month,  the  situation  is  as  fol- 
lows: 

1.  The  ledger  account  "Cash"  represents  exactly  the 
balance  held  by  the  banks  to  the  credit  of  the  concern. 

2.  The  treasurer's  memorandum  book  of  available 
cash  shows  the  amount  of  funds  held  by  the  banks,  against 
which  the  concern  can  draw  by  check. 

3.  The  cash  book  makes  it  possible  to  obtain  the  daily 
balances,  and  to  compute  the  amount  of  interest  which 
has  been  earned. 

4.  The  ledger  account  "Audited  Vouchers  Unpaid" 
represents: 

a.  The  amount  of  vouchers  for  which  no  check  has 

been  drawn 

b.  By  reference  to  the  check  register,  the  amount  of 

vouchers  for  which  checks  have  been  drawn  but 
remain  unpaid 

5.  The  voucher  record  gives,  no  matter  how  required, 
the  exact  detail  of  the  liability  for  audited  vouchers  un- 
paid. 


148      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

6,  The  balance  sheet  shows: 

a.  As  the  books  stand,  what  is  sometimes  called 

the  only  true  financial  status  of  a  concern. 

b.  By    the    application    of    the    following   journal 

entry  the  financial  status  of  the  concern  as  it  is 
customary  to  present  it : 

Audited  Vouchers  Unpaid. .   $. . . . 

To  Cash •  $ 

The  amount  of  vouchers 
for  which  checks  have 
been  issued,  but  are 
still  unpaid  by  banks. 

Expressed  in  book  totals  and  ledger  accounts,  the 
cash  situation,  say  at  June  30,  19 14,  irrespective  of  former 
balances,  is  shown  by  Figures  27-29. 

Nature  of  Petty  Cash 

Petty  cash  may  be: 

I.  A  part  of  the  cash  receipts  of  a  certain  period,  re- 
corded in  the  cash  book,  but  not  deposited  in  the  bank  be- 
cause it  is  to  be  used  for  small  current  disbursements. 
In  this  form,  petty  cash  is  part  of  general  cash,  and  should 
figure  in  the  cash  book  balance  of  the  funds  available  at 
the  end  of  the  period.  Disbursements  made  out  of  petty 
cash  are  temporarily  withheld  from  the  cash  book,  to  be 
recorded  periodically,  or  when  they  have  reached  a  stated 
amount.  Any  petty  cash  book  which  may  be  used  under 
this  method  of  handling  petty  cash,  is  merely  a  memo- 
randum which  has  no  part  in  the  scheme  of  the  financial 
books  of  the  concern.  No  entry  of  any  kind  is  necessary 
to  record  the  withholding  of  receipts  for  petty  cash 
purposes. 


CASH  ACCOUNT— PETTY  CASH        149 

2.  An  amount  withdrawn  from  the  bank,  the  with- 
drawal being  recorded  in  a  ledger  account  known  as 
"Petty  Cash,"  raised  to  reflect  the  outgo  of  small  sums 
of  cash  disbursed  currently  for  items  of  expense  which  are 
loo  small  to  be  conveniently  paid  by  check.  In  this  form, 
the  account  is  independent  of  the  general  cash  account, 
and  its  balance  does  not  figure  in  the  cash  book  balance 
of  available  cash  (unless  sent  back  to  it  periodically).  The 
petty  cash  book  is  also  an  independent  journal  which  is 
used  as  a  posting  medium,  precisely  like  its  more  im- 
portant prototype,  the  general  cash  journal. 

The  expression  in  general  journal  form,  of  the  cash 
book  entry  creating  a  petty  cash  account  as  described  in 
class  2,  is: 

Petty  Cash $ 

To  Cash $ 

The  expression  in  general  journal  form,  of  the  entry 
necessary  to  record  the  petty  cash  disbursements  of  the 
period  in  the  proper  general  ledger  accounts,  is,  say: 

Telephone  and  telegrams $  7.50 

Postage   5.00 

Office  supplies 2.30 

General  expense 17.20 

To  Petty  Cash $32.00 

To  record  the  petty  cash  transactions 
of  the  period. 

3.  An  amount  withdrawn  from  the  bank,  and  set  up  as 
a  fund  intrusted  to  a  petty  cashier  whose  duty  it  is  to 
give  change  and  to  make  all  disbursements  for  petty  ex- 
penses, and  in  settlement  of  invoices  deemed  too  insig- 
nificant to  be  passed  through  the  purchase  journal.  The 
fund  is  recorded  in  a  special  ledger  account,  bearing  as  a 


J50 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


CASH  ACCOUNT— PETTY  CASH 


151 


title  "Petty  Cash  Fund,"  or  "Petty  Cash  Fund— John 
Doe,"  or  some  other  appropriate  name. 

The  expression  in  general  journal  form,  of  the  cash 
book  entry  creating  this  class  of  petty  cash,  is: 

Petty  Cash  Fund — ^John  Doe $ . . . . 

To  Cash $. . . . 

To  create  an  imprest  fund,  to  be 
used  by  John  Doe  for  petty  cash 
disbursements. 

This  method  of  treating  petty  cash  diflfers  from  the 
one  described  under  2,  in  that  it  is  supposed  to  show  no 
fluctuations.  Until  returned  to  the  general  cashier  it 
remains  on  the  ledger  at  the  same  figure.  In  order  to 
make  this  possible,  all  sums  of  money  paid  out  by  the 
petty  cashier  are  returned  to  him  periodically,  or  when- 
ever the  petty  cash  fund  has  been  depleted  to  a  stated 
figure. 

Maintaining  the  Imprest  Fund 

When  the  petty  cashier  desires  to  replenish  his  fund 
he  presents  to  the  general  cashier  a  statement  setting 
forth  his  expenditures,  supported  by  proper  vouchers. 
The  statement  may  be  as  shown  in  Figure  30. 

The  voucher  may  assume  a  much  simpler  form;  the 
essential  point  is  that  the  general  cashier  may  readily 
obtain  the  data  necessary  to  properly  record  in  the  cash 
book  the  expenditures  made  for  him  by  the  petty  cashier. 
The  check  issued  is  either  cashed  by  the  petty  cashier  at 
the  bank,  or  cashed  by  the  general  cashier  himself.  Which- 
ever way  it  is  done,  the  fund  of  the  petty  cashier  is  now  re- 
stored to  its  original  amount.  The  expression  in  general 
journal  form  of  the  entry  made  by  the  general  cashier  in 
the  cash  book  is: 


152      THE    THEORY    OF    THE    ASSET    ACCOUNTS 
/^* $40.00 

B 20.00 

C  65.00 

D 20.00 

E 72.20 

G 32.80 

To  Cash $250.00 

For  disbursements  made  by  the 

petty  cashier. 

Theory  of  the  Imprest  Fund 

It  will  be  noticed  that  at  the  time  the  fund  was  cre- 
ated, the  cash  book  entry  merely  recorded  the  setting 
aside  of  a  portion  of  the  asset  "cash,"  for  purposes  of  petty 
disbursements.  Thus  the  cashier  set  apart  from  his  gen- 
eral funds,  a  sum  of  money  which  he  intrusted,  as  an  "im- 
prest" fund  (money  advanced,  money  loaned,  money  in- 
trusted to  a  paymaster),  to  the  petty  cashier.  This  ex- 
plains why  the  word  "imprest"  is  used  in  qualifying  the 
above  mentioned  method  of  handling  petty  cash.  The 
system  appears  to  have  originated  in  the  Imprest  Office 
of  the  British  Admiralty,  in  connection  with  the  disburse- 
ments made  by  subaltern  paymasters  for  the  account  of 
the  general  paymasters. 

Special  Duties  of  the  Petty  Cashier 

In  some  concerns  one  of  the  duties  of  the  petty  cashier 
is  to  cash  checks  for  the  officers,  the  clients  or  the  cus- 
tomers, and  the  employees.  This  brings  about  complica- 
tions which  necessitate  the  opening  of  a  special  bank  ac- 
count in  the  name  of  the  petty  cashier.  He  deposits  daily 
to  his  credit  the  checks  which  he  has  cashed,  and  draws 
against  the  account  whenever  he  requires  funds.  The 
handling  of  the  fund  is  the  same  as  indicated  in  the  fore- 
going, but  the  memorandum  petty  cash  book  is  arranged 
to  show  the  exchange  and  bank  transactions.     (Figure  31.) 

•  Letters  refer  to  ledger  accounts. 


CASH  ACCOUNT— PETTY  CASH 


153 


CHAPTER  XIV 

ACCOUNTS  WITH  CUSTOMERS 

Entries  in  Customers*  Accounts 

Cash  may  be  affected  by  such  a  diversity  of  transac- 
tions, that  it  is  not  possible  to  state  in  advance  the  sources 
from  which  it  will  come  or  the  channels  through  which 
it  will  go.  Hence,  it  may  be  said  of  the  cash  account  that 
it  possesses  no  well-defined  mechanism.  In  contradis- 
tinction, the  customer's  account  presents  a  series  of 
anatomical  units  with  which  we  may  become  so  thor- 
oughly familiar  as  to  be  able  to  locate  and  assemble  them 
readily,  no  matter  how  scattered  they  may  be. 

As  soon  as  the  word  customers  is  mentioned,  the  mind 
of  the  accountant  reverts  naturally  to  the  business  trans- 
actions which  affect  their  status  on  books  of  record.  We 
think  of  charges  to  them  for: 

1.  Sales  on  credit 

2.  Refunds    when,    having   overpaid    their    accounts, 

they  receive  back  that  which  was  paid  by  them 
without  being  due 
and  of  credits  to  them  for: 

1.  Returned  sales 

2.  Settlements  by  them  in  cash  or  its  equivalent 

3.  Deductions  from  the  amount  receivable  from  them 

in  the  line  of  cash  discounts,  trade  discounts, 
allowances  for  defective  goods,  damaged  goods, 
old  goods,  shortages  in  shipments,  freight  paid 
by  them  and  chargeable  to  the  vendor,  etc.,  etc. 
154 


ACCOUNTS    WITH    CUSTOMERS 


^S5 


Trade  Discounts 

The  only  one  of  the  foregoing  components  of  the  cus- 
tomer's account  which  might  confuse  the  student,  is  trade 
discounts. 

Trade  discounts  are  said  to  be  "deductions  from  price 
Hsts  allowed  to  the  trade,"  They  differ  from  cash  dis- 
counts in  that  the  taking  advantage  of  the  latter  depends 
upon  the  financial  status  or  prompt  payment  of  the  one 
to  whom  it  is  offered,  whereas  the  amount  of  the  former 
will  positively  not  be  included  in  the  customer's  remit- 
tance. A  bill  might  include  two  kinds  of  discounts:  one 
of,  say,  10%  to  be  deducted  from  the  face  of  the  bill,  and 
another  of,  say,  2%  to  be  similarly  deducted  provided  re- 
mittance is  made  within  ten  days.  It  is  clear  that  unless 
the  debtor  is  in  a  position  to  pay  within  the  allotted  time, 
the  only  deduction  which  he  can  make  from  the  bill  is  for 
the  trade  discount  which,  under  all  conditions,  is  no  part 
of  the  contract  of  sale  to  which  he  has  become  a  party. 

If  the  policy  of  the  concern  is  to  charge  all  its  cus- 
tomers with  the  list  or  catalogue  price,  there  are  two  pos- 
sible ways  of  relieving  the  accounts  of  the  beneficiaries  of 
trade  discounts,  of  the  excess  charged  to  them  over  the 
amount  which  they  are  expected  to  pay: 

1.  Let  the  customers  deduct  the  trade  discounts  from 

their  remittances,  and  use  the  cash  book  as  the 
journal  through  which  they  will  receive  credit 
for  the  amount  not  remitted. 

2.  Before  the  customers  remit,  clear  their  account  by 

journal  entry  crediting  them  and  debiting: 

(a)  Trade  Discounts 

(0)  Merchandise,  or  Sales,  or  any  other  account 
which  may  have  been  originally  inflated 
on  the  credit  side  by  the  amount  of  the 
trade  discounts 


ic6     THE    THEORY    OF    THE    ASSET    ACCOUNTS 

It  will  be  noticed  from  the  above  that  the  treatment 
indicated  under  "a"  compels  the  raising  of  a  general 
ledger  account  with  trade  discotints;  whereas  the  second 
treatment,  "b,"  eliminates  the  account  entirely.  This 
means  that,  in  the  first  instance,  there  has  been  created  a 
special  nominal  account  measuring  the  extent  of  the  de- 
duction from  the  income  to  be  received  from  sales,  due  to 
the  desire  of  the  administration  to  favor  dealers  in  order 
that  other  expenses  (such  for  instance,  as  advertising,  or 
salesmen's  salaries  and  commissions)  may  be  correspond^ 
ingly  reduced;  and  that,  in  the  second  instance,  the  special 
nominal  account  has  been  avoided,  in  order  that  the 
already  existing  account  with  merchandise  or  with  sales 
may  show  the  net  result  of  the  sales  as  far  as  income  is 
concerned. 

If  the  policy  of  the  concern  is  to  charge  all  customers 
with  the  net  amount  collectable  under  the  contract  of 
sale,  there  can  be  no  ledger  account  with  trade  discounts, 
and  that  component  will  be  found  neither  in  the  account 
with  customers,  nor  in  the  account  with  merchandise. 
Hence,  whatever  information  might  be  required  in  re- 
gard to  the  extent  of  the  reductions  which  have  been 
made  from  the  catalogue  price,  is  lost  in  so  far  as  the 
ledger  is  concerned,  and  must  be  sought  elsewhere. 

"Accounts  Receivable" 

Before  leaving  the  subject  of  customers'  accounts,  it 
may  be  well  to  call  to  the  attention  of  the  student  the 
fact  that  the  term  "Accounts  Receivable,"  which  is  often 
applied  to  them,  is  to  be  condemned  so  far  as  the  general 
ledger  is  concerned.  The  term  as  generally  understood, 
refers  to  a  balance  sheet  group,  which  is  likely  to  embrace 
a  multitude  of  accounts  other  than  with  customers.  Since 
the  balance  sheet  is  a  financial  statement  purporting  to 
show  the  true  financial  condition  of  the  concern  at  a  given 


ACCOUNTS    WITH    CUSTOMERS 


1.57 


date,  it  can  afford  to  speak  in  concrete  form,  and  to  state 
broad  classes  of  facts  which,  if  not  sufficiently  illuminating 
by  themselves,  can  be  supported  by  explicit  schedules.  It 
is  eminently  proper  for  it  to  include  in  the  group  "Ac- 
counts Receivable,"  accounts  current  with  customers,  ad- 
vances to  agents,  and  claims  against  transportation  com- 
panies which  have  been  recognized  as  valid  and  are  await- 
ing settlement,  etc.  But  it  is  not  proper  for  the  ledger  to 
speak  vaguely;  it  must  index  the  facts  with  at  least  as 
much  care  as  the  journal  takes  in  weighing  them,  and  it 
must  adopt  a  terminology  which  will  place  each  account 
in  a  position  to  state  clearly  what  it  contains. 


CHAPTER  XV 

NOTES  AND  BILLS  RECEIVABLE 

Notes  Receivable 

F.  A.  Cleveland,  in  "Funds  and  Their  Uses"  says  of 
promissory  notes : 

"A  promissory  note  is  a  written  contract  for  the  future 
delivery  of  a  specified  sum  of  money  *  *  *  The  delivery 
must  be  made  on  or  before  a  stated  time,  and  nothing  will 
satisfy  the  contract  except  the  delivery  of  the  particular 
thing  promised." 

Treatment  of  Notes  Receivable 

Assuming  that  a  promissory  note  has  been  given  by  a 
customer  in  settlement  of  his  account,  it  would  appear 
from  the  above  definition  that  the  execution  of  the  in- 
strument of  credit  has  so  altered  the  status  of  his  account 
that  the  change  must  be  recorded.  He  has  indeed  entered 
into  a  second  contract  quite  different  from  the  contract 
of  sale  under  which  he  became  liable  for  the  goods  sold  to 
him  on  credit;  he  has  substituted  a  written  promise  to 
pay  a  certain  sum  of  money  in  a  determinate  future,  for  an 
oral  or  implied  promise  to  pay  a  certain  sum  of  money 
within  a  time  more  or  less  definite.  While  under  the  terms 
of  the  first  contract,  he  could  reduce  his  liability  by  mak- 
ing claims  for  allowances,  or  even  by  returning  part  of  the 
goods  sold  to  him,  nothing  will  satisfy  the  second  con- 
tract, except  the  delivery  of  the  particular  thing  promised. 
Still,  there  are  accountants  who  claim  that  since  the  con- 
sideration for  the  second  contract  is  precisely  the  same  as 

158 


NOTES    AND    BILLS    RECEIVABLE 


159 


the  consideration  for  the  first  contract,  nothing  has  hap- 
pened, so  far  as  accounting  is  concerned,  on  account  of 
the  execution  of  a  promissory  note,  and  no  entry  is  neces- 
sary in  the  customer's  account  until  the  note  has  been  met 
at  maturity,  or  discounted. 

Nevertheless,  it  appears  to  be  the  almost  universal 
custom  to  credit  customers  with  the  amount  of  the  prom- 
issory notes  which  they  give  in  settlement  of  their  ac- 
counts. This  treatment  of  the  matter  is  based  upon  the 
theory  that  an  open  account  with  a  customer  must  be 
proved  if  contested,  whereas  the  promissory  note  is  prima 
facie  evidence  of  value  received;  that  the  time  at  which 
settlement  of  an  account  current  is  demanded  does  not 
alter  the  liability  of  the  debtor,  whereas  the  maker  of  a 
promissory  note  is  liable  only  if  the  instrument  is  pre- 
sented for  payment  at  the  specified  time,  and  surrendered; 
that  when  the  payee  under  a  note  sues  the  party  who  gave 
it  and  dishonored  it,  he  does  not  sue  for  payment  of  a 
customer's  account,  but  for  payment  of  the  note. 

The  usual  way  of  treating  the  general  ledger  account 
with  notes  receivable  is  to  debit  it  with  the  face  value  of 
the  notes  received,  the  counter  entry  being  a  credit  to  the 
customers'  controlling  account,*  and,  if  the  occasion  de- 
mands, to  an  account  with  interest  for  the  excess  which 
the  note  carries  over  the  value  of  the  account  for  which 
it  settles;  and  to  credit  the  account  with  the  amount  of 
the  note  when  it  is  met  at  maturity,  or  as  soon  as  it  has 
been  discounted  at  the  bank,  the  counter  entry  being  a 
debit  to  cash,  in  the  first  instance,  and  a  debit  to  cash  and 
to  interest  and  discount  in  the  second  instance. 

Treatment  of  Contingent  Liability  on  Notes  Discounted 

The  discounting  of  notes  receivable  raises  the  ques- 
tion of  the  liability  of  the  one  who  has  discounted  it,  to 

•  This,  of  course,  necessitates  a  credit  to  the  account  of  the  customer  in  the 
subsidiary  ledger. 


j6o    the  theory  of  the  asset  accounts 

the  broker  or  bank  which  has  purchased  the  paper.  Leslie 
J.  Tompkins  says  in  regard  to  the  liability  of  the  parties  to 
a  note:  "Every  party  to  a  negotiable  instrument,  whether 
he  be  the  drawer  or  maker,  acceptor  or  indorser,  enters 
into  a  contract  which,  in  some  respects,  differs  from  that 
entered  into  by  each  of  the  other  parties  named.  This 
contract  carries  with  it  certain  liabilities  which  he  cannot 
evade."  Since  the  customer's  note  has  been  transferred 
to  the  discounting  bank  by  indorsement,  it  follows  that 
the  liability  of  the  transferrer  is  contingent  upon  the  dis- 
honor of  the  note  at  maturity.  The  desire  to  express  this 
contingent  liability  on  the  books  of  concerns  which  re- 
ceive many  promissory  notes  and  discount  them  regu- 
larly, has  brought  about  a  handling  of  the  account  with 
notes  receivable,  which  appears  to  give  quite  a  twist  to 
the  principles  of  double  entry. 

We  have  said  that  an  incoming  value  is  counterbal- 
anced by  an  outgoing  value  equal,  inferior,  or  superior  to 
it.  Applying  this  principle  to  the  discounting  of  a  prom- 
issory note,  we  would  say  that  there  has  come  in  a  value 
(cash)  inferior  to  the  outgoing  value  (promissory  note  re- 
ceivable) and  that,  as  a  consequence,  there  has  come  into 
the  business  a  loss  under  the  form  of  discount.  Thus, 
equilibrium  having  been  disturbed  by  the  outgo  of  the 
note,  has  been  reestablished  by  the  receipt  of  cash,  and 
the  recording  of  a  loss  equivalent  to  the  excess  of  the 
outgo  over  the  income.  But  under  the  theory  that  the 
contingent  liability  must  be  recorded,  this  is  what  takes 
place: 

Notes  Receivable  remains  unaffected  in  so  far  as  the 
books  are  concerned;  Cash  is  debited  with  the  amount  re- 
ceived, Interest  and  Discount  is  debited  with  the  amount 
charged  by  the  bank,  and  a  liability  account  known  as 
"Promissory  Notes  Discounted"  is  credited.  As  soon  as 
information  is  obtained  in  regard  to  the  payment  of  the 


NOTES    AND    BILLS    RECEIVABLE  igi 

notes  at  maturity,  the  liability  account  is  debited,  and 
Notes  Receivable  is  credited  with  the  face  value  of  the 
note  which  has  been  met. 

If  we  were  to  submit  this  treatment  to  the  rigid  test  of 
the  principles  of  accounting,  we  would  see  that  it  does 
not  express  the  transactions  as  they  occurred.  When  the 
bank  discounts  a  note,  it  does  not  purchase  the  vendor's 
contingent  Hability  under  the  note;  nor  does  it  give  its 
money  in  exchange  for  that  liability.  It  purchases  a  com- 
mercially negotiable  instrument  which,  at  the  time  of  sale, 
was  recorded  on  the  books  of  the  vendor  concern  as  an 
asset.  In  other  words,  it  purchases  an  asset.  Of  course 
the  bank  buys  the  instrument  subject  to  its  being  met  by 
the  maker  at  maturity,  and  if  the  instrument  proves  with- 
out value,  the  purchaser  will  call  upon  the  vendor  to  make 
good  the  loss;  but  that  Hability  of  the  vendor  is  prob- 
lematic, whereas  there  is  no  question  but  that  his  asset 
"notes  receivable"  has  been  sold.  This  is  precisely  the 
reason  why  some  accountants  object  to  showing  the  lia- 
bility for  discounted  notes  on  the  balance  sheet  otherwise 
than  as  a  footnote.  Somewhere  between  the  two 
methods,  other  accountants  claim  to  have  found  the  only 
true  expression  of  the  facts.  They  show  the  notes  receiv- 
able at  the  full  value  of  the  instruments  unmatured, 
whether  held  or  discounted,  and  deduct  therefrom  on  the 
asset  side  of  the  balance  sheet,  the  contingent  liability. 
Hence,  the  asset  as  extended  represents  the  exact  value 
of  the  notes  held. 

Dishonored  Notes 

In  regard  to  the  dishonor  of  promissory  notes  at  ma- 
turity, the  handling  differs  according  as  to  whether  they 
were  discounted  or  held  until  due  date.  In  the  former 
case,  the  treatment  differs  also  as  to  whether  the  record- 
ing of  the  discount  was  made  in  the  account  "Promissory 


1 62      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

Notes,"  or  in  the  "Contingent  Liability"  account.  Dis- 
honored notes  which  have  previously  been  discounted  and 
credited  to  the  asset  account,  are  treated  as  follows: 

1.  Credit  Cash  with  the  amount  of  the  note  and  oi 

the  protest  fee  paid  to  the  bank. 

2.  Debit  the  maker  of  the  note  with  the  face  value  of 

the  dishonored  instrument,  as  well  as  with  the 
amount  of  the  protest  fee,  or: 
Debit   customers'   controlling  account   with   the 
face  value  of  the  note  and  the  amount  of  the  fee. 

Dishonored  notes  which  have  been  discounted,  and 
credited  at  the  time  to  the  contingent  liability  account 
"Promissory  Notes  Discounted,"  require  the  following 
entries : 

1.  Credit  Cash  with  the  amount  of  the  note  and  of 

the  protest  fee  paid  to  the  bank. 

2.  Debit  "Promissory  Notes  Discounted"  with  the 

face  value  of  the  note,  and  the  maker  of  the  in- 
strument with  the  protest  fee. 

3.  Credit  Notes  Receivable  with  the  face  value  of  the 

note. 

4.  Debit  the  maker  of  the  note  with  the  face  value  of 

the  dishonored  instrument,  or: 
Debit   customers'   controlling   account   with   the 
face  value  of  the  note,  and  the  amount  of  the 
fee. 

Dishonored  notes  which  have  not  been  discounted,  re- 
quire the  following  entries: 

1.  Credit  Notes  Receivable  with  the  face  value  of  the 

note. 

2.  Credit  Cash  with  the  amount  of  the  protest  fee 

paid. 


NOTES    AND    BILLS    RECEIVABLE  163 

3.  Debit   the  maker  of  the   dishonored  instrument 

with  the  face  value  of  the  note  as  well  as  with 

the  amount  of  the  fee,  or: 
Debit  customers'  controlling  account  with  both 

the  amount  of  the  instrument,  and  the  amount 

of  the  fee. 
The  theory  underlying  the  debit  to  the  maker  of  the 
dishonored  instrument,  is  to  the  efifect  that  since  the  note 
so  altered  the  status  of  the  customer's  account  that  it 
had  to  be  closed,  it  cannot  now  be  reopened. 

The  theory  underlying  the  debit  to  the  customer  who 
gave  the  promissory  note  which  is  now  dishonored,  is  to 
the  effect  that  the  consideration  for  the  promissory  note 
being  the  same  as  the  consideration  for  the  recording  of 
the  claim  against  the  customer  in  the  first  instance,  it  is 
quite  correct  to  reopen  an  account  which  was  closed,  upon 
the  assumption  that  the  instrument  of  credit  would  be 
met  at  maturity.  This  latter  theory  does  not  appear  to 
have  the  courage  of  its  convictions;  if  it  is  true  that  the 
nature  of  the  customer's  account  was  not  sufficiently 
altered  by  the  execution  of  the  promissory  notes  to  pre- 
clude its  being  reopened,  then  it  seems  that  it  should  not 
have  been  closed  at  all. 

Bills  Receivable 

The  asset  account  "Notes  Receivable"  is  frequently 
found,  in  practice,  under  the  name  of  "Notes  and  Bills 
Receivable,"  and  not  infrequently  under  the  generic  name 
of  "Bills  Receivable."  So  far  as  accounting  is  concerned, 
the  theory  of  these  two  classes  of  commercial  instruments 
does  not  dififer  materially;  still,  there  is  good  reason  why 
it  might  be  better  to  keep  separate  accounts  with  them. 

"A  bill  of  exchange,"  says  Mr.  Tompkins  in  his  book, 
"The  Law  of  Commercial  Paper,"  is  an  unconditional 
order  in  writing  addressed  by  one  person  to  another, 


l64     THE    THEORY    OF    THE    ASSET    ACCOUNTS 

signed  by  the  person  giving  it,  requiring  the  person  to 
whom  it  is  addressed  to  pay  on  demand,  or  at  a  fixed  or 
determinable  future  time  a  sum  certain  in  money  to  order 

or  to  bearer." 

Thus  a  bill  of  exchange  introduces  into  the  relations 
between  the  proprietor  of  the  business  and  his  customer, 
a  third  person,  the  drawee,  who,  after  the  bill  has  been 
presented  to  him,  becomes  the  acceptor,  that  is  to  say, 
the  party  liable  to  the  payee.  This  alters  the  liability  of 
the  customer  to  the  proprietor  of  the  business;  from 
primary  it  becomes  secondary.  No  such  alteration  of 
liabiUty  is  found  in  a  promissory  note. 

Whether  or  not  the  keeping  of  separate  accounts  with 
notes  and  bills  is  deemed  advisable  by  a  concern  whose 
custom  it  is  to  receive  both  classes  of  instruments,  it 
seems  that  a  concern  which  receives  promissory  notes 
only,  should  not  permit  the  use  of  the  term  "bills  receiv- 
able" on  its  ledger.  The  very  name  of  the  ledger  account 
gives  misleading  information. 

The  opinion  held  upon  this  subject  by  W.  M.  Cole,  of 
Harvard  University,  is  quite  different  from  the  one  ex- 
pressed above — 

"The  account  in  which  negotiable  notes  are  recorded 
is  called  'Bills  Receivable.'  Drafts  which  have  been  ac- 
cepted by  those  upon  whom  they  are  drawn,  are  also  recorded 
in  Bills  Receivable;  but  drafts  which  have  not  been  accepted 
are  not  recorded  at  all  on  the  principal  books,  for  until 
accepted  they  have  no  value  other  than  that  of  any 
written  request.  It  should  be  noted  that  Bills  Receivable 
has  a  restricted  significance,  and  does  not  at  all  include 
ordinary  so-called  'open  accounts'  or  'book  accounts,' 
i.  e.,  sums  owed  to  a  business  by  customers  to  whom  it  has 
sold  goods  on  trust.  The  term  'Bills  Receivable'  is  used 
only  of  promises  to  pay,  written  in  the  form  of  promis- 
sory notes  or  of  accepted  drafts." 


CHAPTER  XVI 

ACCOUNTS  WITH  GOODS 

Merchandise  Account  of  Trading  Concerns 

The  original  purpose  of  this  account  was  to  gather  the 
factors  which  affected  the  gross  profits  on  merchandise. 

It  will  be  remembered  that  when  speaking-  of  the  prin- 
ciples of  double-entry  bookkeeping,*  it  was  said  that  in- 
coming values  greater  than  the  outgoing  values  which 
they  replaced,  produced  a  gain  which  should  be  recorded 
in  a  nominal  account.  So  far  as  merchandise  is  concerned, 
this  could  not  be  done  conveniently,  unless  the  cost  of 
every  object  sold  were  known  by  the  bookkeeper.  If  this 
were  the  case  and  he  were  able  to  furnish  the  physical 
effort  which  such  bookkeeping  would  require,  his  entry 
would  be,  for  every  sale: 

Customer  (or  Cash) $50.00 

To  Merchandise $35-00 

"    Profit  on  Merchandise i5-00 

It  was  found  convenient  to  credit  the  goods  account 
with  the  sale  price  of  the  goods  sold,  and,  periodically,  to 
apply  to  it  the  value  of  the  inventory  remaining  on  hand. 
Thus  the  skeleton  of  the  merchandise  account  is  merely 
this: 


Debits 
Initial  inventory 
Purchases  of  the  period 
Gross  profit  on  sales 

•  Page  70. 


Credits 
Sales  of  the  period 
Closing  inventory 


165 


l66     THE    THEORY    OF    THE    ASSET    ACCOUNTS 

But  since  both  goods  purchased  and  goods  sold  are 
likely  to  prove  unsatisfactory  to  the  buyer,  it  follows  that 
original  debits  made  to  the  merchandise  account  are  true 
only  if  none  of  the  goods  have  been  sent  back  to  the  ven- 
dor; and  that  original  credits  are  true  only  if  none  of  the 
goods  have  been  returned  by  the  customer.  When  goods 
sold  are  returned,  the  merchandise  account  is  debited  in 
order  that  the  sale  may  be  canceled ;  and  when  goods  pur- 
chased are  sent  back,  the  merchandise  account  is  credited 
in  order  that  the  purchase  may  be  canceled.  At  this  point, 
the  structure  of  the  account  is  as  follows : 


Debits 
Initial  inventory 
Purchases  of  the  period 
Returned  sales  of  the  period 
Gross  profit  on  sales 


Credits 
Sales  of  the  period 
Returned  purchases  of  the  period 
Closing  inventory 


Inasmuch  as  the  purpose  of  the  merchandise  account 
is  to  show  the  true  gross  profit  on  sales,  it  is  evident  that 
losses  due  to  merchandise  being  destroyed  as  unfit  to  be 
sold,  or  to  deterioration  reducing  its  value,  must  be  ac- 
counted for;  and  it  is  also  plain  that  unless  this  is  done 
before  inventory  time,  by  a  credit  to  the  goods  and  a  debit 
to  profit  and  loss,  the  profit  shown  by  the  merchandise 
account  will  not  be  the  profit  on  sales,  and  the  profit  and 
loss  account  will  fail  to  convey  proper  information  in  re- 
gard to  extraordinary  losses.  Thus,  the  components  of 
the  merchandise  account  have  become : 


Debits 
Initial  inventory 
Purchases  of  the  period 
Returned  sales  of  the  period 
Gross  profit  on  sales 


Credits 
Sales  of  the  period 
Returned  purchases  of  the  period 
Merchandise  destroyed 
Closing  inventory 


It  has  been  denied  that  the  merchandise  account 
should  ever  go  further  than  this.  On  the  other  hand,  it 
has  been  claimed  that  if  thus  restricted  it  cannot  show* 


ACCOUNTS    WITH    GOODS 


167 


1.  On  the  debit  side: 

a.  The  cost  of  freight  and  cartage  incurred  on 

the  goods  purchased. 

b.  The  cost  of  the  freight  and  cartage  on  sales, 

which  the  vendor  has  agreed  to  pay  in 
order  that  he  might  obtain  for  his  goods 
the  price  recorded  by  the  sales. 

c.  The  deductions  which  the  vendor  has  agreed 

to  make  from  the  catalogue  price,  if  his 
policy  is  to  record  all  sales  at  that  price. 

d.  The  freight  and  cartage  paid  by  the  vendor 

on  goods  returned  to  him  by  customers. 

2.  On  the  credit  side: 

a.  The  proportion  of  the  freight  and  cartage  in- 

ward which  applies  to  goods  unsold. 

b.  The  freight  and  cartage  paid  on  goods  pur- 

chased which  have  been  returned  to  the 
vendors. 

c.  The  trade  discounts  which  would  reduce  the 

cost  of  the  goods  purchased,  in  case  they 
have  been  recorded  at  catalogue  price. 

The  above  components,  gathered  according  to  their 
nature,  show  the  structure  of  the  merchandise  account  to  be : 


Debits 

Credits 

I. 

Initial  inventory 

I. 

Sales 

2. 

Purchases  of  the  period 

2. 

Returned  purchases 

3- 

Freight  and  cartage  inward  on 

3. 

Freight    and    cartage    inward, 

purchases 

paid  at  time  of  purchase,  on 

4- 

Freight   and   cartage   outward 

purchases  now  returned 

on  sales 

4- 

Trade  discounts  on  purchases 

5- 

Returned  sales 

5. 

Merchandise  destroyed  as  un- 

6. 

Freight  and  cartage  inward  on 

fit  for  sale 

returned  sales 

6. 

Deterioration   of   merchandise 

7. 

Trade  discounts  on  sales 

7. 

Freight    and    cartage    inward 

8. 

Gross  profit  on  merchandise 

on   purchases,  applicable  to 
goods  unsold 

8. 

Closing  inventory 

l68     THE    THEORY    OF    THE    ASSET    ACCOUNTS 

Analysis  of  the  Merchandise  Account 

Prior  to  the  division  of  the  journal  into  its  components 
(purchases,  sales,  purchases  returned,  sales  returned,  cash, 
etc.)  the  merchandise  account,  being  posted  daily,  con- 
tained a  multitude  of  unclassified  facts  which  required  ex- 
tensive analysis  in  order  to  show  how  the  gross  profit  was 
obtained.  This  is  still  the  case  whenever  detail  posting  is 
in  vogue.  But  when  books  of  original  entry  are  so  con- 
structed as  to  permit  of  the  monthly  gathering  of  posting 
material,  the  merchandise  account  becomes  a  perfect  sum- 
mary of  trading  transactions.  As  each  class  of  facts  is  sup- 
ported by  details  to  be  found  in  analytical  journals,  no 
analyses  are  necessary,  and  the  material  for  financial  state- 
ments is  obtained  by  merely  adding  together  the  compo- 
nents of  like  nature  as  found  in  the  accounts  for  the  ac- 
counting period. 

Subdivisions  of  the  Merchandise  Account 

It  has  become  the  fashion  to  advocate  the  abandon- 
ment of  the  "old-fashioned  merchandise  account."  A 
series  of  "simple"  accounts,  each  one  containing  one  of  the 
components  of  the  old  account,  will,  it  is  claimed,  give 
better  results  without  analysis.  It  must  be  borne  in  mind, 
however,  that  after  all  the  components  of  the  merchandise 
account  have  been  raised  to  the  dignity  of  individual  ac- 
counts, they  represent  nothing  more  than  the  monthly 
footings  of  columns  of  journals,  and  that  in  order  to  lead 
to  a  conclusion  in  regard  to  the  result  to  which  they  all 
have  contributed  in  a  positive  or  in  a  negative  way,  they 
must  be  methodically  gathered  either  in  a  trading  ac- 
count, or  in  the  profit  and  loss  account. 

^  The  accounts  which  are  to  be  opened,  to  satisfy  the  re- 
quirements of  this  theory,  are  the  very  components  ex- 
pressed in  the  foregoing,  in  connection  with  the  merchandise 


ACCOUNTS    WITH    GOODS  169 

account.     Their  accounting  treatment  at  the  end  of  the 

period  is  expressed  by  journal  entries  as  follows : 

Freight  and  Cartage  Inward  on  Purchases  Returned    $ 

To  Freight  and  Cartage  Inward  on  Purchases  $ 

To  reduce  the  latter  account  to  the  amount  of  the 
uncanceled  transaction. 

Freight  and  Cartage  Inward  applicable  to  subsequent 

periods $ 

To  Freight  and  Cartage  Inward  on  Purchases  $ 

To  set  up  as  a  deferred  debit  item  the  portion  of 
freight  applicable  to  future  sales. 

Returned  Purchases  of  Trading  Merchandise $ 

To  Purchases  of  Trading  Merchandise $ 

To  reduce  the  latter  account  to  the  amount  of  the 
uncanceled  transactions. 

Inventory  of  Trading  Merchandise $ 

To  Purchases  of  Trading  Merchandise $ 

For  portion  of  purchases  of  the  period,  not  sold, 
and  still  held  as  an  asset. 

Trade   Discounts   on    Purchases   of   Trading   Mer- 
chandise         $ 

To  Purchases  of  Trading  Merchandise     $ 

To  deduct  from  cost  of  purchases  the  price  list  de- 
duction to  which  we  are  entitled. 

Profit  and  Loss $ 

To  Purchases  of  Trading  Merchandise $ 

"   Freight  and  Cartage  Inward  on  Purchases.  

To  close  in  the  summary  account  the  purchase 
cost  of  the  goods  sold,  and  the  additional  cost 
of  handling. 

Sales  of  Trading  Merchandise $ 

To  Returned  Sales  of  Trading  Merchandise..  $ 

To  reduce  the  former  account  to  the  amount  of 
the  uncanceled  transactions. 

Sales  of  Trading  Merchandise $ 

To  Trade  Discounts  on  Sales $ 

To  deduct  from  the  income  from  sales  the  price 
list  deduction  to  which  our  jobbers  arc  entitled. 

Sales  of  Trading  Merchandise $ 

To  Profit  and  Loss $ 

To  close  in  the  summary  account  the  gross  in- 
come obtained  from  sales. 


I70     THE    THEORY    OF    THE    ASSET    ACCOUNTS 


Profit  and  Loss • '  *  •         *     ^ 

To  Freight  and  Cartage  Outward  on  Sales  of 

Trading  Merchandise * 

For  cost  of  forwarding  to  f.  o.  b.  points,  according 
to  agreement  with  customers. 

Profit  and  Loss * 

To  Trading  Merchandise  Unfit  for  Sale f 

"    Deteriorated  Trading  Merchandise 

For  loss  of  capital  having  no  relation  with  pur- 
chases and  sales,  but  connected  with  trading 
merchandise. 

As  a  result  of  the  above  entries,  the  Profit  and  Loss 
account  will  exhibit  the  following  skeleton : 

Profit  and  Loss 


Sales    of    Trading    Mer- 
chandise   


1.  Cost    of    Purchase    of 

Merchandise  Sold: 

a.  Cost  of  Purchases 

Sold    $..-. 

b.  Cost  of  Handling, 

Inward 

2.  Freight    and    Cartage 

Outward  on  Sales 

3.  Merchandise  Unfit  for 

Sale   

4.  Deteriorated      Trading 

Merchandise   

The  gross  profit  on  merchandise  results  from  the  deduc- 
tion of  the  above  debits  i  and  2,  from  the  only  credit  con- 
tained in  the  account. 

It  is  pointed  out  that  whether  the  gathering  of  merchan- 
dise components  is  done  monthly  in  the  merchandise  account, 
or  only  at  the  end  of  a  period,  in  the  Profit  and  Loss  account, 
makes  no  difference  whatever.  Since  one  of  the  main  ob- 
jects of  accounting  is  so  to  gather  financial  facts  that  it  will 
be  possible  readily  to  obtain  financial  statements,  it  must  be 
admitted  that  complex  accounts  posted  from  analytical  books 
of  original  entry  are  equally  as  satisfactory  as  simple  ac- 
counts which  are  supposed  to  render  the  ledger  analytical. 


ACCOUNTS    WITH    GOODS 


171 


Inventory  of  Trading  Merchandise 

The  inventory  of  a  trading  concern  should  be  valued 
at  cost.  It  has  been  held  that  it  is  proper  to  compute  it 
on  the  basis  of  the  market  value,  if  such  a  value  is  smaller 
than  cost;  but  it  is  generally  denied  that  a  market  value 
higher  than  cost  can  be  used.  If  the  lower  value  is  al- 
lowed, there  is  no  reason  why  the  higher  one  should  not 
be.  There  is,  however,  a  good  reason  why  market  values 
should  not  be  used  at  all.  Accounting  is  not  interested  in 
what  would  have  happened  "if,"  but  in  what  has  actually 
happened;  and  since  the  goods  unsold  were  purchased  at 
a  certain  price,  the  profits  realized  are  to  be  measured  by 
comparing  that  price  with  the  proceeds.  To  reduce  the 
inventory  to  a  value  lower  than  cost,  is  to  add  to  the  cost 
of  the  goods  sold  during  the  period;  and  to  raise  the  in- 
ventory to  a  value  greater  than  cost,  is  to  reduce  the  cost 
of  the  goods  during  the  period.  In  either  case,  the  result 
is  contrary  to  the  truth. 

The  taking  of  a  physical  inventory  at  the  end  of  every 
accounting  period  is  customary  with  all  trading  concerns 
selling  goods  which  are  subject  to  shrinkage,  to  deteriora- 
tion by  exposure,  to  thefts,  or  to  errors  in  weighing  at 
time  of  purchase  and  of  sale.  When,  however,  these  con- 
ditions are  not  present,  it  is  not  unusual  to  find  that  a 
book  inventory  is  considered  quite  satisfactory.  In  such 
cases,  the  purchases  of  merchandise  are  entered  by  classes 
of  goods,  in  a  "merchandise  stock  book"  showing,  on  the 
debit  side,  the  quantities  purchased,  their  cost  per  unit, 
and  their  money  value;  in  the  credit  column,  the  quanti- 
ties sold,  their  cost  per  unit,  and  the  money  value  of  the 
sales,  an  average  being  established  if  the  occasion  arises; 
in  the  balance  column,  the  quantities  remaining,  their  cost 
per  unit,  and  their  money  value,  and,  if  prices  are  sub- 
ject to  fluctuations,  or  have  fluctuated,  the  average  cost  and 
money  value.     (See  Figure  32.) 


172 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


ACCOUNTS    WITH    GOODS 


173 


Merchandise  Accounts  of  Manufacturing  Concerns 

Traders  sell  their  goods  in  the  shape  in  which  they 
purchase  them;  manufacturers  sell  "finished  goods" 
which  have  undergone  a  "manufacturing  process"  in  the 
course  of  which  labor  has  been  expended,  materials  and 
supplies  consumed,  and  expenses  incurred.  Thus,  so  far 
as  the  goods  are  concerned,  there  are  three  distinct 
stages: 

1.  The  stage  when  they  are  in  their  raw  state 

2.  The    stage   when   they   are    "in   process"    (or   in 

"progress") 

3.  The  stage  when  they  are  "finished" 

As  they  pass  from  stage  to  stage,  the  goods  accumu- 
late cost,  until,  upon  completion,  they  stand  precisely  in 
the  same  relation  to  the  manufacturer  as  trading  goods 
do  to  the  trader.  Thus,  it  may  be  said  that  the  "Finished 
Goods"  account  is  the  "Merchandise"  account  of  the 
manufacturer,  built  up  from  its  sundry  components: 


Debits 

Credits 

Initial  inventory 

Sales 

Cost  of  goods  finished  during  the 

Closing  inventory 

period 

Returned  sales 

Gross  profit  on  sales 

As  to  the  elements  of  cost  which  the  goods  manufac- 
tured accumulate  while  passing  from  stage  to  stage,  they 
may  be  briefly  stated  as  follows: 

I.    Raw   Material  Stage    (Ledger  Account:   "Raw    Ma- 
terials") : 

a.  The  cost  of  purchase  of  materials  and  supplies 

b.  The  cost  of  freight  and  cartage  inward  thereon 

c.  The  cost  of  handling  and  storing  them 

The  last  two  items  have  sometimes  been  referred 
to  as  "Pre-Proccss  Cost." 


174      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

2.  Goods  in  Process  Stage  (Ledger  Account:  "Goods  in 
Process") : 

a.  Cost  of  raw  materials  transferred  from  stores 

b.  Productive  labor,  that  is  to  say,  the  skilled  labor 

which  produces  the  finished  goods,  and  can  be 
allocated: 

(i)  To  the  product  at  large  if  only  one  class  of 
goods  is  manufactured 

(2)  To  individual  units  of  production  if  several 

classes  of  goods  are  manufactured 

(3)  To  job  numbers  in  either  case 

This  labor  is  consumed  for  the  production  of  the 
manufactured  goods  only,  and  has  nothing  to 
do  with  the  other  phases  of  the  activities  of  the 
factory. 

c.  Manufacturing  burden  (also  called  manufacturing 

overhead),  that  is  to  say,  the  expenses  incurred 
in  connection  with  the  operations  of  the  factory, 
which,  while  part  of  the  cost  of  manufacture, 
cannot  be  allocated  to  any  given  unit  of  the 
production,  and  must  be  apportioned  thereto  on 
some  scientific  basis.    It  includes: 

( I )  Unproductive  labor : 

(a)  Superintendence  and  supervision,  in- 

cluding the  salaries  of  the  superin- 
tendent, and  of  his  assistants,  and 
the  wages  of  the  foremen. 

(b)  All  the  unskilled  labor  which,  while  not 

directly  expended  on  the  manufac- 
tured product,  is  necessary  and 
beneficial  thereto,  or  is  required  in 
order  that  the  factory  may  continue 
as  an  organized  body. 


ACCOUNTS    WITH    GOODS 


175 


(2)   Factory  expenses,  such  as  fuel,  light,  power, 
rent,  sundry  supplies,  repairs  to  machinery 
and  tools,  tools  consumed  as  a  result  of 
operations,  and,  if  operating  reserves  are 
considered  better  than  surplus  appropria- 
tions, the  estimated  depreciation  of  machin- 
ery and  tools. 
d.  General   factory  burden   (also  called  general   fac- 
tory overhead).    When  the  organization  of  the 
factory  is  such  that  it  is  run  as  a  distinct  de- 
partment, any  expense  which  is  called  for  by 
that  very  organization,  such,  for  instance,  as  the 
keeping  of  factory  records,  the  cost  of  station- 
ery and  printing,  the  estimated  depreciation  of 
the  factory  buildings  and  factory  building  equip- 
ment, etc.,  must  be  apportioned  to  the  cost  of 
the  goods  in  process. 

J.    Finished   Goods  Stage    (Ledger   Account:   "Finished 
Goods"): 

a.  When  goods  have  passed  through  the  "process" 
stage,  and  are  ready  for  sale,  their  cost  is  cred- 
ited to  the  account  "Goods  in  Process,"  and 
debited  to  the  account  "Finished  Goods."  At 
this  point,  we  really  have  a  manufactured  mer- 
chandise account,  which  differs  from  the  trad- 
ing merchandise  account,  only  in  that  the  latter 
shows  every  unit  of  its  mechanism,  while  the 
Finished  Goods  account  receives  from  an  inter- 
mediary, a  unit  composed  of: 

(1)  Purchase  cost  of  goods  ready  to  be  sold, 
including  the  following  components  of 
the  merchandise  account: 

(a)  Initial  inventory  of  goods  purchased 

(b)  Purchases  of  the  period 


176     THE    THEORY    OF    THE    ASSET    ACCOUNTS 

(c)  Freight    and    additional    cost    of 

goods  purchased 
Less: 

(d)  Closing  inventory  of  goods  pur- 

chased, inflated  by  additional  cost 
applicable  thereto 
(2)  Manufacturing  cost  of  goods  purchased 
and  made  ready  to  be  sold 

The  components  of  the  Finished  Goods  account  are : 


Debits 

Initial  inventory  of  goods  finished 
and  unsold  during  the  prior 
period 

Cost  of  goods  manufactured  dur- 
ing the  present  period 

Returned  sales 

Allowances  on  sales 

Trade  discounts 

Gross  manufacturing  profit 


Credits 
Sales 
Closing  inventory 


If  the  system  of  bookkeeping  which  has  been  adopted, 
provides  for  separate  accounts  for  sales  and  for  the  trans- 
actions incident  thereto,  the  Finished  Goods  account  is 
reduced  to  the  functions  of  a  species  of  Inventory  ac- 
count, of  which  the  following  are  the  components: 


Debits 
Initial  inventory 

Cost  of  goods  manufactured  dur- 
ing the  period 


Credits 

Closing  inventory 

Cost  of  manufactured  goods  sold 
(debited  to  profit  and  loss  or  to 
a  group  account  "Cost  of  Goods 
Sold,"  which  is,  in  turn,  closed 
into  the  Profit  and  Loss  ac- 
count) 


Inventories  of  the  Merchandise  Accounts  of  Manufacturing 
Concerns 

At  the  close  of  the  accounting  period,  the  valuation  of 
inventories  of  raw  materials,  sundry  supplies,  goods  in 


ACCOUNTS    WITH    GOODS 


177 


process,  and  finished  goods,  presents  serious  difficulties, 
unless  the  cost  system  of  the  concern  is  sufficiently  de- 
veloped to  give  positive  and  ready  data  concerning  the 
manufacturing  process. 

Inventory  of  Raw  Materials  and  Sundry  Supplies 

If,  in  connection  with  the  raw  materials  and  the  sun- 
dry supplies,  there  is  kept  a  stock  ledger  (Figure  33),  a 
book  inventory  may  be  obtained  which  will  check  the 
accuracy  of  the  physical  inventory,  or  which  may  even  be 
allowed  to  take  its  place.  The  stock  ledger  is  so  arranged 
that  it  contains  an  account  with  each  class  of  merchandise. 
Individual  accounts  are  debited  with  the  quantity,  the 
cost  per  unit,  and  the  total  money  value  of  the  initial  in- 
ventory (if  any)  and  of  the  purchases  of  the  period;  and 
credited  with  the  quantity,  cost  per  unit,  and  money  value 
of  the  material  which  goes  out  upon  requisitions.  In- 
formation is  supplied  also  as  to  the  destination  of  the  out- 
going material.  The  difference  between  the  debits  and 
credits  gives  the  quantity  and  money  value  of  the  goods 
remaining  in  store;  it  also  gives  the  cost  per  unit  if  the 
units  have  been  acquired  at  a  uniform  figure.  In  the  con- 
trary case,  the  average  cost  price  must  be  obtained  as  well 
for  the  amount  of  the  goods  remaining  on  hand  as  for 
the  value  of  the  goods  requisitioned  for  factory  or  other 
purposes.  If  no  stock  ledger  is  kept,  a  physical  inventory 
is  essential,  the  pricing  of  which  will  have  to  be  established 
by  reference  to  the  purchase  invoices  of  the  period.  The 
process  will  be  not  only  lengthy,  but  inaccurate,  unless  a 
great  deal  of  care  is  exercised. 

It  will  be  noticed  that  the  example  submitted  affords 
useful  information  to  the  purchasing  agent,  in  that  it  in- 
dicates the  exact  quantity  of  material  ordered  which  has 
not  as  yet  been  received  at  inventory  time,  or  at  any  other 
time.     It  also  gives,  under  the  heading  "General  Order 


178 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


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Note'    If  any  material  is  returned  +o  stores  after  having  been  issued, 
give  the  number  of  the  credit  slip  in  the  column  for  Purchase  Order. 
Ear-mark  in  such  a  manner  as  to  make  it  possible  to  nsadily  ascer- 
tain the  extent  of  the  cancelled  issues  of  the  period. 

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ACCOUNTS    WITH    GOODS 


179 


No.":  the  quantity  and  the  amount  of  material  which  has 
been  consumed  for  purposes  other  than  for  manufacture, 
such  as  repairs  and  maintenance,  additions  to  plant,  etc. 

Inventory  of  Goods  in  Process 

If  the  concern  has  an  adequate  system  of  cost  account- 
ing-, the  recapitulation  of  the  cost  sheets  (Figure  34)  estab- 
lished for  job  numbers  or  for  stock  numbers  (or  for  both) 
still  in  progress,  will  give  the  inventory  value  of  the  asset 
"goods  in  process,"  provided  it  is  customary  to  apply  the 
overhead  burden  of  a  period  to  the  processes  of  that 
period.  If  the  custom  is  to  apply  the  burden  to  finished 
goods  only,  either  the  pricing  of  the  inventory  of 
"goods  in  process"  will  have  to  take  into  consideration, 
subject  to  a  subsequent  reversal  of  the  entry,  the  propor- 
tion of  the  burden  applicable  to  the  goods  when  com- 
pleted; or  there  will  have  to  be  created  a  special  account 
which  will  contain  the  said  burden,  in  order  that  it  may  be 
withheld  from  the  cost  of  operations,  and  shown  in  the 
balance  sheet  as  a  deferred  debit  to  cost  of  goods  under- 
going process  of  manufacture. 

With  minor  alterations  in  the  descriptive  and  statisti- 
cal part  thereof,  Figure  34  can  be  used  for  factories  which 
operate  on  job  numbers. 

Inventory  of  Finished  Goods 

Under  a  proper  cost  finding  and  cost  recording  system, 
the  valuation  of  the  inventory  of  finished  goods  is  estab- 
lished precisely  like  that  of  goods  in  process,  by  recapitu- 
lating the  cost  sheets  relating  to  the  job  (or  stock)  num- 
bers which  have  not  been  sold  during  the  period. 

Inventory  When  There  Is  No  Cost  System 

If  there  is  no  cost  system,  the  valuation  of  the  inven- 
tories of  goods  in  process  and  of  finished  goods  will  have 


i8o 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


ACCOUNTS  WITH   GOODS  i8i 

to  be  established  by  what  might  be  called  the  **dead- 
reckoning"  method.  A  satisfactory  basis  will  have  to 
be  found  for  the  appHcation  of  labor  and  overhead  ex- 
penses to  the  material  represented  by  the  two  classes  of 
goods.  Under  these  conditions,  it  is  evident  that  no  ac- 
countant is  in  a  position  to  pass  upon  the  accuracy  of  the 
figures  submitted.  His  task,  however,  instead  of  being 
lightened  by  this  exemption  from  responsibility,  will  be 
materially  increased  owing  to  the  difficult  character  of 
the  periodical  adjustments  to  be  made  in  order  that  the 
general  books  may  support  the  financial  statements  which 
he  will  submit. 

The  inventory  of  raw  materials  and  sundry  supplies, 
when  applied  to  the  net  debit  of  the  general  ledger  ac- 
count therefor,  will  give  the  consumption  of  materials  and 
supplies  during  the  period,  either  for  manufacturing  pur- 
poses, or  for  the  general  purposes  of  the  plant.  The  divid- 
ing line  between  these  two  classes  of  facts  will  be  given  by 
an  analysis  of  all  the  available  factory  records  and 
memoranda  which  may  throw  any  light  whatever  on  the 
subject.  The  amount  used  for  manufacturing  purposes 
will  be  transferred  to  the  debit  of  a  ledger  account 
"Goods  in  Process"  raised  for  the  purpose  of  obtaining 
the  cost  of  the  goods  put  in  progress  during  the  period, 
while  the  amount  used  for  the  plant  will  be  debited  to  the 
different  accounts  with  subdivisions  of  the  plant,  or  to 
Repairs  and  Maintenance  account.  To  the  account  "Goods 
in  Process"  will  be  debited  separately: 

1.  The  productive  labor 

2.  The  factory  manufacturing  overhead 

3.  The  factory  general  overhead 

applicable  thereto,  as  ascertained  from  analyses  of  the 
pay-roll  and  other  records,  and  from  the  classification  of 
the  nominal  factors  disclosed  by  the  general  books  or  by 


lg2      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

analyses  thereof,  and  as  distinguished  from  the  propor- 
tion of  these  items  which  is  to  be  charged  to  capital  ac- 
counts or  to  repairs  and  maintenance  accounts.  At  this 
point,  the  account  "Goods  in  Process"  will  contain  the 
total  cost  of  the  manufacturing  activities  of  the  factory 
for  the  whole  period. 

It  will  now  be  necessary  to  credit  the  account,  and  to 
debit  Finished  Goods,  with  the  difference  between  the 
total  value  of  the  individual  items  i,  2,  and  3,  and  material, 
and  the  amount  thereof  said  to  be  applicable  to  the  goods 
unfinished  and  still  on  hand  at  the  end  of  the  period. 

The  balance  remaining  in  the  account  "Goods  in 
Process,"  will  be  the  inventorial  value  of  that  asset. 

The  last  step  will  be  to  credit  the  Finished  Goods  ac- 
count with  the  value  of  an  inventory  which  will  be  estab- 
lished by  adding  to  raw  material  value  of  goods  on  hand,  a 
proper  proportion  of  productive  labor,  and  a  proper  pro- 
portion of  the  two  classes  of  factory  burden.  The  balance 
of  the  account  will  be  transferred  direct  to  Profit  and  Loss, 
or  to  an  intermediate  account  "Cost  of  Goods  Manufac- 
tured and  Sold,"  which  will  in  turn  be  transferred  to  the 
Profit  and  Loss  account  and  opposed  to  the  sales  in  order 
that  the  gross  profit  may  be  known. 

Apportionment  of  Overhead  Expenses 

The  application  of  overhead  expense,  at  inventory 
time,  to  quantities  remaining  in  process,  reveals  the  im- 
portance of  the  subject  of  distribution,  and  raises, 
naturally,  the  question  of  the  basis  for  such  distribution. 

z.    Labor  Rates 

It  is  claimed  by  some  accountants  that  a  satisfactory 
basis  is  found  in  the  division  of  the  total  of  each  class  of 
overhead  (or  of  the  two  classes  together),  by  the  total 
amount  of  productive  labor  consumed  during  the  period. 


ACCOUNTS    WITH    GOODS 


183 


This,  they  say,  gives  the  rate  to  be  used  in  the  distribu- 
tion of  overhead,  to  jobs,  to  orders,  or  to  general  classes 
of  goods  manufactured.  Others  maintain  that  this  basis 
will  be  moderately  accurate,  only  if  the  operators  relate  to 
a  single  class  of  product,  and  if  the  quantity  produced  is 
practically  the  same  from  month  to  month.  They  suggest 
that  a  more  accurate  application  of  the  burden  could  be 
made  on  the  basis  of  the  ratio  which  the  annual  total  bur- 
den bears  to  the  annual  total  hours  of  direct  labor  con- 
sumed by  each  class  of  goods,  or  each  job  number  or  order 
number. 

2.     Machine  Rates  ^ 

There  are  still  others  who  claim  that  while  productive 
labor  has  been,  up  to  modern  times,  the  essential  and  prob- 
ably the  basic  factor  of  cost,  it  has  so  far  ceased  to  be  so 
in  these  days  of  machinery  as  to  practically  eliminate  the 
element  of  human  skill  from  the  work  performed  by  the 
so-called  "productive  laborers."  They  suggest  the 
"machine  rate"  as  the  only  satisfactory  basis  on  which  to 
apply  overhead  expenses.  This  means  that  the  burden  is 
to  be  distributed  on  the  basis  of  the  ratio  that  it  bears  to 
the  total  number  of  hours  of  work  produced  by  the  oper- 
ating machines. 

Going  still  further,  some  claim  that  neither  basis  will 
be  effective  if  applied  to  the  manufacturing  as  a  whole,  but 
that  both  may  work  well  when  applied  to  each  and  every 
department  of  the  factory  subdivided  into  as  many  de- 
partments as  there  are  phases  of  the  process. 

To  continue  the  nomenclature  of  distribution  bases 
we  may  mention  the  "material"  rate,  the  "labor  and  ma- 
terial" rate,  and  the  "old  machine"  rate,  the  "new  ma- 
chine" rate,  and  the  "pay"  rate. 

The  "new  machine"  rate  is  especially  interesting  be- 
cause it  attempts  to  accumulate  upon  the  machines  which 


l84      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

produce  the  goods  in  a  particular  department,  the  total 
cost  of  operations  of  that  department,  including  all  labor; 
and  thus,  it  is  possible  to  obtain  the  hour  cost  of  operat- 
ing a  machine.  The  manufacturing  cost  of  the  goods  pro- 
duced in  a  department  is  then  found  by  multiplying  the 
machine  hours  required  for  the  production  of  the  goods,  by 
the  cost  of  the  machine  hour. 

The  Problem  of  Expense  Distribution 

Whatever  may  be  the  views  of  accountants  upon  the 
matter  of  expense  distribution,  "production  and  effi- 
ciency" engineers  scorn  them.  Hamilton  Church  says  in 
his  book  on  "Production  Factors  in  Cost  Accounting  and 
Works  Management": 

"The  error  which  dominates  and  vitiates  all  the  usual 
and  popular  methods  of  dealing  with  indirect  expense  is 
simply  'analysis.'  This  is  the  rock  on  which  they  all  founder. 
For  the  purposes  of  the  accountant  this  analysis  is  suffi- 
cient, because  the  accountant  is  concerned  neither  with 
the  efficiency  nor  with  the  improvement  of  production. 

"It  does  not  matter  greatly  to  him  whether  a  particu- 
lar item  of  expense  is  due  to  inefficient  power  distribution, 
or  to  worn-out  machinery,  or  to  buildings  imperfectly 
adapted  to  their  uses.  To  him  an  expense  is  an  expense; 
but  to  the  production  engineer  it  may  be  more  than  an  ex- 
pense— it  may  be  a  revelation.  Yet,  as  long  as  we  persist 
in  looking  on  all  the  activity  and  all  the  expenditure  go- 
ing on  in  and  about  a  works  as  due  to  production,  so 
long  will  the  accountant's  point  of  view  necessarily  hold 
the  field.  As  long  as  we  shut  our  eyes  to  the  fact  that 
actual  production  is  the  last  organization  in  a  chain  of 
separate  organizations,  so  long  will  the  present  confused 
ideas  about  indirect  expenses  or  establishment  charges 
hold  their  ground  unshaken." 

It  is  not  the  intention  to  enter  into  a  discussion  of 


ACCOUNTS    WITH    GOODS  185 

cost  accounting-,  or,  as  it  has  been  termed  of  late  "cost 
finding."  This  branch  of  accounting  is  far  too  extensive 
to  permit  of  its  being  even  sketched  in  the  present  volume. 
Be  it  sul^cient  to  state  that  articles  are  published  almost 
daily  on  the  application  of  factory  overhead,  and  that  the 
subject  deserves  the  special  attention  of  the  student  who 
has  mastered  the  principles  of  accounting. 


CHAPTER  XVII 

CONSIGNMENTS— SHIPMENTS    INWARD 

Relations  of  Consignor  and  Consignee 

While  the  subject  of  consignments,  from  the  point  of 
view  of  modern  business  practice,  is  far  less  important  to- 
day than  it  was  fifty  or  sixty  years  ago,  it  has  lost  none  of 
its  importance  from  the  viewpoint  of  the  accountant, 
since  it  gives  rise  to  the  difficult  problems  of  agency  ac- 
counting. 

So  far  as  the  consignee  is  concerned,  he  may  be: 

1.  A  "factor,"  otherwise  known  as  a  "commission 

merchant,"  whose  business  consists  in  selling 
merchandise  belonging  to  others  in  considera- 
tion of  a  "factorage"  or  "commission"  agreed 
upon. 

2.  An  individual  or  concern  engaged  in  any  line  of 

business,  whose  facilities  for  selling  in  a  desir- 
able market  make  it  profitable  to  engage  him  or 
it  occasionally  to  act  as  a  factor  in  return  for 
proper  compensation. 

Consignments  made  to  either  class  of  consignees  estab- 
lish, between  the  parties,  the  relation  of  principal  and  agent. 
There  is,  however,  this  difference:  certain  states  of  the 
Union  license  regular  factors  and  bond  them,  whereas  no 
state  requires  either  bond  or  license  from  an  occasional 
consignee. 

i86 


CONSIGNMENTS— SHIPMENTS    INWARD  187 

Consignee's  Duties  and  Liabilities 

The  factor  (or  commission  merchant)  and  the  occa- 
sional consignee  (or  correspondent)  owe  the  principal  for 
whom  they  act  as  agents,  such  ordinary  care  of  consigned 
goods  as  a  prudent  person  would  take  of  property  in- 
trusted to  him.  They  are  not  liable  for  losses  due  to 
causes  over  which  they  could  not,  in  reason,  be  expected 
to  have  control;  but  they  are  liable  for  all  losses  due  to 
their  failure  to  carry  out  instructions  which  they  have  re- 
ceived from  their  principals.* 

Factors  may  act  under  specific  or  under  general  in- 
structions. In  the  first  instance,  they  must  sell  at  the 
price  fixed  by  the  consignor;  in  the  second  instance,  they 
must  sell  at  the  highest  price  obtainable,  and  exert  due 
diligence  to  that  end.  The  term  "due  diligence"  is  not 
understood  to  include  foresight  in  connection  with  sudden 
fluctuations  of  prices.  If  the  agreement  entered  into  is 
to  the  effect  that  the  goods  will  be  sold  at  no  less  than  a 
certain  price,  a  sale  by  the  consignee  at  less  than  the  said 
price  is  in  the  nature  of  a  violation  of  specific  instructions, 
and  makes  him  liable  for  the  difference. 

In  the  absence  of  specific  instructions  to  the  contrary, 
a  factor  may  sell  on  credit;  if  he  does  so,  and  exercises 
proper  diligence  in  ascertaining  the  financial  responsi- 
bility of  purchasers,  he  is  not  liable  for  losses  due  to  their 
subsequent  failure.  What  is  still  more  important  to  the 
accountant,  the  factor  is  not  liable  to  his  principal  for  the 
money  value  of  sales  until  he  has  collected  the  amount 
due  thereunder.  This  rule,  however,  does  not  apply  where 
the  factor  has  lacked  prudence  in  giving  credit;  or  where 
he  has  been  negligent  in  attending  to  collections;  and, 
lastly,  where  he  operates  under  the  provision  of  a  *'del 
credere"  agreement,  that  is  to  say,  when  he  has  agreed,  in 

*  Scott  V.  Rogers,  31  N.  Y.  676,  holds  that  a  consignee  who  had  received  in- 
structions to  sell  goods  on  a  certain  day  at  a  specific  price,  or  to  ship  them  to  a 
certain  place,  and  had  done  neither,  was  guilty  of  a  "conversion"  of  the  goods. 


l88      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

consideration  of  a  higher  commission,  to  hold  himself  re- 
sponsible for  the  proceeds  of  all  sales  made  by  him  as 
agent. 

If  the  consignee  is  under  specific  instructions  to  sell 
for  cash,  or  on  credit  upon  the  pledge  of  security,  he  is 
liable  for  all  losses  due  to  his  failure  to  comply. 

A  consignee  may  incur,  for  the  account  of  his  prin- 
cipal, such  expenses  as  are  necessary  for  the  protection  of 
the  merchandise  consigned  to  him,  and  such  losses  or  al- 
lowances as  are  necessary  to  the  validity  of  his  sales.  His 
doing  either  or  both,  creates  in  his  favor  a  lien  on  the 
goods,  similar  to  the  one  which  he  obtains  by  making  ad- 
vances to  his  principal.  The  lien  for  expenses  extends  to 
customs  duties,  marine  and  fire  insurance,  freight  and  cart- 
age, storage,  weighing,  handling,  packing,  unpacking,  etc. 
The  lien  for  losses  extends  to  allowances  for  defective 
goods,  shortages  in  weight,  faulty  packing,  etc. 

The  question  of  advances  by  the  consignee  to  the  con- 
signor is  all  the  more  important,  because  some  legal 
authorities  hold  that  advances  give  the  factor  the  right 
to  sell  enough  of  the  consigned  goods  to  satisfy  his  claim. 
Even  when  selling  for  advances,  however,  some  of  the 
authorities  hold  that  he  is  bound  to  obey  his  instructions 
regarding  the  price  at  which  the  goods  should  be  sold. 

The  consignee  has  no  right  to  pledge  as  his  own,  goods 
received  by  him  on  consignment.  But  if  he  has  made  ad- 
vances to  his  principals,  he  may,  in  order  to  secure  his  own 
debts,  deposit  an  amount  of  goods  equivalent  to  his  ad- 
vances, provided  he  gives  the  third  party  due  notice  that 
the  goods  are  merely  liened  to  him,  and  not  owned  by 
him.* 

Unless  the  instructions  received  by  the  factor  ex- 
pressly forbid  him  to  do  so,  he  may  accept  promissory 


^      •Urquhart  v.  Mclver.  4  Johns  (N.  Y.)  103;  Silverman  v.  Bush,  16  III.    App. 


CONSIGNMENTS— SHIPMENTS    INWARD 


189 


notes  in  settlement  of  consigned  goods  sold;  if  he  has  duly 
ascertained  the  standing  of  the  maker  of  the  note  at  the 
time  of  its  execution,  and  has  not  discounted  the  note 
for  his  own  use,  he  is  not  Uable  for  the  dishonor  of  the 
instrument,  due  to  a  subsequent  failure  of  the  maker. 

The  acceptance  of  consignments  by  a  factor,  makes  it 
imperative  for  him  to  comply  with  such  disposition  of  the 
proceeds  as  his  principals  may  wish  to  make.  If  money 
is  due  his  principals  he  cannot  refuse  to  accept  a  draft 
drawn  by  them  to  the  order  of  a  third  party,  provided  he 
has  notice  of  the  draft. 

Unless  specific  provisions  to  that  efifect  exist  in  the 
agreement  between  the  principal  and  the  factor,  or  unless 
such  a  provision  can  be  implied,  either  from  the  contract 
or  from  custom,  the  factor  is  not  chargeable  with  inter- 
est except  when  he  fails  to  render  account  at  the  proper 
time,  and  to  remit  when  he  should  do  so. 

The  Factor's  Accounts  and  Accounting 

Under  this  general  heading,  the  Cyclopaedia  of  Law 
and  Procedure  says  of  factors:* 

"The  factor  must  account  to  his  principals  for  goods 
sold  *  *  *  he  must,  when  reasonably  requested,  present 
to  his  principal  a  full,  complete,  and  specific  account  of  his 
dealings  between  themselves,  and  between  the  factor  and 
the  purchasers.  It  is  held  that  it  is  the  factor's  duty  to 
be  prompt  in  rendering  an  account  of  his  sales,  whether 
requested  to  do  so  or  not,  and  that  a  failure  to  render  an 
account  for  an  unreasonable  time  will  render  him  liable, 
especially  where  a  demand  is  impracticable  or  highly  in- 
convenient. That  he  may  render  a  satisfactory  account, 
it  is  his  duty  to  keep  books  in  which  are  entered  correct 
accounts  of  his  transactions,  and  the  books  should  be 
subject  to  the  principal's  inspection,  and  the  principal  is 


*  Cyc,  Vol.  XIX,  p.  135- 


IQO      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

entitled  to  a  correct  copy  of  the  entries  in  the  books,  in- 
cluding all  memoranda  connected  therewith.  Accounts 
current  are  necessarily  provisional  until  settled,  and  even 
after  settlement  may  be  rectified  for  errors  and  omissions, 
subject  to  which  every  settlement  is  made;  but  if  the  fac- 
tor render  his  account  in  good  faith,  and  the  principal 
makes  no  objection  to  it,  the  principal's  assent  to  it  as 
correct  is  presumed;  and  unless  objection  is  made  within 
reasonable  time  his  principal  will  be  bound  by  the  ac- 
counting rendered." 

Francis  B.  Tififany,  in  his  "Handbook  of  the  Law  of 
Principal  and  Agent,"  says  of  the  agent's  duty  to 
account : 

"It  is  the  duty  of  the  agent  to  account  to  the  principal 
for  all  the  money  and  property  coming  into  his  hands  by 
virtue  of  his  employment,  including  all  profits  resulting 
from  the  transactions,  either  as  agent,  or  on  his  own  ac- 
count in  breach  of  his  duty  as  agent. 

"His  specific  duties  in  this  respect  are: 

1.  To  keep  accounts  of  all  his  transactions  in  the 

course  of  the  agency,  and  to  render  his  accounts 
whenever  required  by  the  terms  of  his  employ- 
ment, or  upon  demand. 

2.  To  keep  money  and  property  of  the  principal  sepa- 

rate from  his  own,  and  from  those  of  third  per- 
sons. 

3.  To  pay  or  deliver  to  the  principal  all  money  and 

property  of  the  principal  coming  into  his  hands 
as  agent,  whether  required  by  the  terms  of  the 
employment,  or  upon  demand." 

Books  of  the  Factor- 

The  foregoing  remarks  concerning  the  rights,  duties, 
and  privileges  of  the  factor,  commission  m'erchant,  or  con- 


CONSIGNMENTS— SHIPMENTS    INWARD  191 

signee,  appear  to  leave  him  no  choice  but  to  make  his  ac- 
counting comply  with  the  spirit  of  the  statutes.  As  to  the 
accounting  method  which  he  will  adopt,  he  may  choose 
between  two  distinct  treatments: 

1.  He  may  record  in  his  own  general  books  all  the 

transactions  affecting  consignments,  in  such  a 
manner  as  to  keep  what  he  owns  and  what  he 
owes  as  a  business  man  separate  from  that 
which  he  holds  as  factor,  and  for  which  he  is 
accountable  to  his  principals. 

2.  He  may  record  in  special  agency  books,   all  the 

transactions  affecting  consignments,  and  periodi- 
cally transfer  to  his  own  books  the  results  of  his 
activities  as  factor,  in  so  far  as  they  have  affected 
his  assets,  his  liabilities,  and  his  income. 

Books  of  the  Factor — Agency  Accounts  Kept  in  General 
Books 

Since  one  of  the  accounting  duties  of  the  factor  is  to 
keep  the  money  and  the  property  of  his  principal  sepa- 
rate from  his  own,  and  from  those  of  third  persons,  it  fol- 
lows that,  if  he  keeps  only  one  set  of  books,  he  must: 

1.  Open  a  separate  account  with  each  consignment 

and  with  each  consignor. 

2.  Keep  a  separate  bank  account  for  each  individual 

consignor,  and  one  for  himself. 

3.  Record   separately   purchases   and   sales   of,    and 

profits  on,  merchandise  traded  in  by  him  on  his 
own  account. 

4.  Separate  the  accounts  of  his  own  customers  from 

those  of  the  customers  of  his  principals,  and 
keep  separate  controlling  accounts  with  the  cus- 
tomers of  each  consignor. 


IQ2      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

5.  So  plan  his  books  of  account,  that  they  will  differ- 
entiate: 

a.  The  factor's  own  assets,   and   the  assets  of 

his  individual  principals,  the  latter  includ- 
ing: 

(i)  The  goods  held  on  consignment,  re- 
corded at  their  consigned  value. 

(2)  The  cash  deposited  in  his  name,  but  as 
agent  for  his  individual  principals, 
and,  if  conditions  warrant,  the  un- 
settled consignments,  customers'  bal- 
ances, and  unmatured  promissory 
notes  receivable. 

b.  The  factor's  own  liabilities,  and  the  credit  ac- 

counts necessary  to  counterbalance  the  prin- 
cipals' assets  held  by  him;  these  credit  ac- 
counts, which  are  merely  contras  of  the  prin- 
cipals' unrealized  assets,  or  represent  matur- 
ing liabilities  to  the  extent  of  the  reaUzed 
assets,  comprise : 

( 1 )  The  contra  of  the  consigned  goods  ac- 

count, that  is  to  say,  the  consignor's 
individual  goods  account. 

(2)  The  consignor's  individual  account  cur- 

rent containing  the  proceeds  of  the 
sales,  less  the  charges  made  by  the 
factor  for  advances  or  expenses,  or 
both  and  for  commissions. 

Thus,  a  theoretical  trial  balance,  before  the  closing 
of  the  general  ledger  of  the  factor  whose  books  have 
been  kept  according  to  the  above  described  method,  might 
be: 


CONSIGNMENTS— SHIPMENTS    INWARD 


193 


Trial  Balance 
Of  the  books  of  John  Harrison,  Commission  Merchant 

(Before  Closing) 


Furniture  and  Fixtures 
— J.  Harrison $  3,000.00 

General  Cash — ^J.  Harri- 
son       1,650.00 

Customers — J.  Harrison.       725.50 

Allowances  to  Customers 
— J.  Harrison 25.00 

Merchandise — J.  Harri- 
son       5,000.00 

General  Expense  —  J. 
Harrison   300.00 


$10,700.50 

Consignment  No.  i . . . . 

.$  4,000.00 

No.  2.... 

.    3,500.00 

No.  3.... 

.     1,660.00 

Cash— J.  H.,  Agent- 

Account  No.  I 

.    4,015.00 

No.  2 

340.00 

No.  3 

50900 

Promissory  Notes — Con 

- 

signor  No.  3 

150.00 

Customers  —  Consignor 

No.  3 

500.00 

$14,674-00 

Total  Debits 

•  $25,374.50 

Creditors — J.  Harrison.. $  1,561.50 

Notes  Payable — J.  Har- 
rison    750.00 

Sales — J.  Harrison 7,000.00 

Commissions — ^J.  Harri- 
son    55140 

Capital — J.  Harrison 3,499.00 


$13,361.90 


Consignor  No.  i — Goods 
Account  $  4,000.00 

Consignor  No.  2 — Goods 
Account  31,500.00 

Consignor  No.  3 — Goods 
Account 1,660.00 

Consigrnor  No.  i — Ac- 
count Current (a)     1,613.50 

Consignor  No.  2 — Ac- 
count Current (b)        196.00 

Consignor  No.  3 — Ac- 
count Current (c)     1,043.10 


$12,012.60 


Total  Credits $25,37450 


(a)  Charged  with  commissions  of  $401.50,  and  with  advances  of  $2,000.00 

(b)  "  "  "  "      34.00,   "       "    expenses"       110.00 

(c)  "  "  «  "     1 15.90 


$551.40 


$2,110.00 


194 


THE  THEORY  OF  THE  ASSET  ACCOUNTS 


It  will  be  noticed  that  the  difference  between  the 
assets  of  his  principals,  held  by  John  Harrison,  and  the 
credit  accounts  which  he  has  created  to  offset  them  or  to 
reflect  his  accountability  therefor,  is  precisely  the  amount 
of  the  commission,  advances,  and  expenses,  charged  by 
him  to  the  individual  account  current  of  the  consignor 
liable  therefor.  We  shall  shortly  see  what  accounting 
steps  the  factor  must  take  to  close  his  books,  and  to  ad- 
just his  own  assets,  as  well  as  the  assets  of  his  principals: 
let  us  now  express  in  concrete  form  the  journal  entries 
made  by  him  so  far  as  consignments  are  concerned,  dur- 
ing the  period  which  is  about  to  close: 


consignment    ac- 


1.  Debit: 

Individual 
counts 
Credit : 
Individual  consignors'  goods 
accounts 

2.  Debit: 

Individual  consignors'  goods 
accounts 
Credit : 

Individual    consignment    ac- 
counts 

3.  Debit: 

Individual  consignors'  cash 
accounts  (or  promissory 
notes  receivable,  or  con- 
signment customers'  con- 
trolling accounts) 
Credit : 

Individual     consignors'      ac- 
cotints  current 


with  the  consigned 
value  of  the  goods 
received. 


with  the  consigned 
value  of  the  goods 
sold. 


with  the  sale  price 
of  the  goods  sold. 


CONSIGNMENTS— SHIPMENTS    INWARD 


195 


Debit: 

Individual    consignment    ac- 
counts 
Credit : 

Individual  consignors'  goods 
accounts 

Debit: 

Individual     consignors'      ac- 
counts current 
Credit : 

Individual  consignors'  cus- 
tomers' controlling  ac- 
counts 


with  the  consigned 
"■  value    of    sales    re- 
turned. 


with  the  sale  price 
of  the  goods  sold, 
now  returned.* 


ac- 


or 
or 


Debit: 

Individual      consignors' 
counts  current 
Credit : 

a.  Factor's    cash    account, 

creditors'     accounts 
both 

b.  Factor's  commission  account 

Debit: 

a.  Individual  consignors'  cash 

accounts    or    promissory 
notes  receivable 

b.  Individual   consignors'  ac- 

counts current 
Credit : 
Individual     consignors'     cus- 
tomers'     controlling      ac- 
counts 


with  advances  made 
to,  and  expenses 
paid  and  incurred 
for  the  account  of 
the  principal,  and 
with  the  commis- 
sion earned  on  the 
sale  of  his  goods. 


a.  with  settlements 
made  by  customers. 

b.  with    allowances 
'  and  rebates  made  by 

the  factor  in  accord- 
ance with  his  in- 
structions. 


•  In  connection  with  the  return  of  cash  sales  credit  the  individual  eonsignor'l 
cash  account  with  the  amount  of  the  refund. 


•iq6    the  theory  of  the  asset  accounts 


8.  Debit: 

Individual     consignors'     ac- 
counts current 

Credit: 
Individual    consignors'    cash 
accounts 


with  the  cash  re- 
mittances made  by 
the  factor,  or  with 
the  disposition  of 
the  cash  proceeds  as 
per  instructions. 


Passing  now  to  the  closing  of  the  factor's  books,  let 
us  assume: 

1.  That  the  inventory  of  his  own  merchandise  shows 

a  value  of  $1,500. 

2.  That  the  end  of  his  accounting  period  corresponds 

with  the  time  at  which  he  must  account  to  his 
principals,  and  remit  the  cash  proceeds  of  the 
sales,  there  being  in  his  agreement  with  them 
no  specification  as  to  his  being  liable  for  un- 
collected proceeds  of  sales. 

The  expression  in  journal  form  of  the  entries  which  he 
will  have  to  make  to  adjust  his  own  accounts  is: 

First  Entry : 

Merchandise,  New  Account,  J.  H $1,500.00 

To  Merchandise,  Old  Account,  J.  H $1,500.00 

To  set  up  the  inventorial  value  of  my  trading 
merchandise,  as  per  inventory  of 

Second  Entry: 

Profit  and  Loss $3,825.00 

To  Merchandise,  Old  Account,  J.  H $3,500.00 

Allowance  to  Customers,  J.  H 25.00 

General  Expense,  J.  H 300.00 

To  close  into  profit  and  loss,  the  cost  of  the 
trading  goods  sold  by  me  for  my  own  ac- 
count, and  my  expenses  and  losses  of  the 
period. 


CONSIGNMENTS— SHIPMENTS    INWARD 


197 


Third  Entry : 

Sales,  J.  H $7,000.00 

Commissions,  J.  H 551.40 

To  Profit  and  Loss $7,551.40 

To  close  into  profit  and  loss  income  obtained 
by  me  on  the  sales  of  my  own  trading  mer- 
chandise, and  the  commissions  which  I  have 
earned  as  factor,  as  follows : 

Consignor  No.  i $401.50 

Consignor  No.  2 34-00 

Consignor  No.  3 115.90 

Fourth  Entry: 

General  Cash,  J.  H $2,661.40 

To  Cash,  J.  H.,  Agent,  Account  No.  i $2401.50 

2 144.00 

"       "         "  "  "  "   3 IIS-QO 

For  checks  drawn  to  my  order,  in  settlement 
of: 

a.  My  advances  to  Consignor  No. 

I  $2,000.00 

b.  Expenses  paid  for  the  account 

of  Consignor  No.  2 iio.oo 

c.  Commissions  on  sales : 

Consignor  No.  i $401.50 

Consignor  No.  2 34-00 

Consignor  No.  3 1 15.90     551.40 

The  expression  in  journal  form,  of  the  entries  neces- 
sary to  adjust  the  accounts  of  the  principals,  is: 

Consignor  No.  i.  Account  Current $1,613.50 

"    2,        "  "      196.00 

"    3,        "  "      393.10 

To  Cash,  J.  H.,  Agent,  Account  No.  i $1,613.50 

"       "       "         "  "  "2 196.00 

"       "        "         "  "  "   3 393.10 

For  remittance  to  my  principals,  of  the  pro- 
ceeds of  the  cash  sales  of  the  goods  con- 
signed to  them,  in  accordance  with  the  terms 
of  my  employment  as  factor. 

At  this  point  the  trial  balance  of  the  factor's  ledger 
will  show: 


Io8      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

Trial  Balance 
Of  the  books  of  John  Harrison,  Commission  Merchant 

(After  Closing) 


Furniture  and  Fixtures 
—J.  Harrison $  3,000.00 

General  Cash— J.  Harri- 
son         4,31140 

Customers— J.  Harrison.       725-50 

Merchandise  — J.  Harri- 
son       1,500.00 


$  9,536.90 

Consignment  No.  i $  4,000.00 

"             "     2 3,500.00 

"             "     3 1,660.00 

Promissory  Notes — Con- 
signor No.  3 150.00 

Customers  —  Consignor 

No.  3 500.00 


$  9,810.00 


Total  Debits $19,346.90 


Creditors— J.  Harrison.. $  1,561.50 

Notes  Payable— J.  Har- 
rison         750.00 

Profit  and  Loss— J.  Har- 
rison       3,726.40 

Capital— J.  Harrison 3,4990O 


$  9,536.90 

Consignor  No.  i — Goods.$  4,000.00 
"    2         "        3,500.00 
"           "   3         "         1,660.00 
"   3    Ac- 
count Current 650.00 


$  9,810.00 


Total  Credits $19,346.90 


The  nature  of  the  account  sales  which  the  factor  will 
have  to  render  his  principals,  will  be  sufficiently  explained 
by  the  following  illustration: 

Account  Sales 
New  York,  June  30,  19 14 

Sale  of  40  Cases  of  Merchandise  by  John 
Harrison,  Commission  Merchant,  for  the  Ac- 
count of  H.  Marlow,  Boston,  Mass. 
Tune    1,  1912    Received,  by  Steamer  Commonwealth,  freight 
and  charges  prepaid: 

123  cases  at  $20.00 $2,4160.00 

30  Inventory : 

83  cases  at  $20.00 1,660.00 

Sale  of  40  cases — Consigned  to  me  at  $20.00 $800.00 


CONSIGNMENTS— SHIPMENTS    INWARD  199 

Sales  and  Proceeds : 

On  Credit,  60  days:     _  Sales 

T  c    Tk/r  11       tr  t.  t        Cases    Price  Proceedi 

June    9  S.  MuUer,  Hoboken, 

N.  J 10    $29.00    $290.00 

"     IS                     Th.    Kemp,   Middle- 
town,  N.  Y 7      30.00      210.00       $500.00 


On  Credit,  Secured  by 
Note,  60  days : 
8  M.  Turner,  Buffalo, 

N.  Y s      30.00  150.00 

For  Cash: 
aa  S.    Archbold,     New 

York,   N.   Y 18      28.277  509.00 


Total    40  $1,159.00 

Held  until  Collection,  as  per  agree- 
ment : 

Accounts   Receivable $500.00 

Promissory   Note 150.00        650.00 


Proceeds  Subject  to  Remittance $509.00 

Charges  to  Your  Account : 

Freight,  Cartage,  etc.   (None)....     $ 

Allowances  to  Customers    "      

Commissions  of  10%  on  all  sales, 

as    per    agreement — My    Check 

No drawn  against  you 115.90         115.90 


Net  Cash  Proceeds,  Remitted  Here- 
with, Check  No $393.io 


John  Harrison, 
E.  &  O.  E.  Commission  Merchant. 

It  will  be  noticed  that  the  foregoing  account  sales 
gives,  practically,  a  copy  of  the  transactions  recorded  by 
the  factor  on  his  books.  This  is  no  more  than  he  owes  to 
his  principals. 

The  account  reflects  the  debits  and  the  credits  made 
to  the  consignment  account  (Dr.  $2,460.00;  Cr.  $800.00), 
and  the  balance  of  the  account   ($1,660.00).     It  also  re- 


200 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


fleets  the  credits  given  and  the  debits  made  to  the  current 
account  of  the  consignee,  and  the  balance  of  that  account 
(Cr.^  $1,159.00;  Debits:  Commissions,  $115.90;  Cash, 
$393.10;  Total,  $509.00;  Balance,  $650.00)  and  finally,  it 
gives  the  amounts  debited  to  Cash,  to  Accounts  Receiv- 
able, and  to  Promissory  Notes  Receivable,  and  the 
amounts  credited  to  Cash. 

Books  of  the  Factor — Agency  Accounts  Kept  in  Separate 
Books 

The  second  method  differs  from  the  first,  only  in  that 
it  compels  the  factor  to  keep,  in  connection  with  the 
agency  work,  a  separate  set  of  books  comprising: 

1.  General  ledger 

2.  Consignments  received  book 

3.  Consignment  sales  book 

4.  Agency  cash  book 

5.  Agency  journal 

6.  Consignment  customers  ledger 

Each  book  must  be  so  arranged  that  all  the  trans- 
actions will  be  classified  with  due  respect  to  the  individual 
consignor  whose  accounts  they  afifect.  The  accounts  kept 
will  be  precisely  the  ones  referred  to  in  connection  with 
the  first  method  and  the  results  obtained  will  be  similar 
in  every  respect.  Figures  35  and  36  illustrate  forms  of 
these  books. 

These  books  may  be  either  loose-leaf,  or  bound.  In 
either  case  as  many  pages  are  devoted  to  each  consignment 
as  may  be  needed  according  to  the  tenor  of  the  agreement. 

The  space  allotted  to  each  individual  consignor  is  ear- 
marked by  a  tab  bearing  the  number  given  to  the  series  of 
accounts  which  contain  all  the  transactions  with  him. 

Reference  to  the  consignment  agreement,  the  number  of 
which  appears  in  the  consignments  received  book,  will  give 
all  required  information  when  the  occasion  arises. 


CONSIGNMENTS-SHIPMENTS    INWARD 


201 


IK) 


^ 


u 


85 


iJ. 


1^ 


S 


202 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


CONSIGNMENTS— SHIPMENTS    INWARD  203 

The  Recording  of  Consignments  Inward — Occasional  Con- 
signee 

The  general  books  already  described  will  be  found 
to  work  to  the  satisfaction  of  the  trader  or  manufacturer, 
who,  for  valuable  consideration,  is  willing  to  sell  goods  for 
the  account  of  others  when  the  occasion  arises;  and  this, 
whether  or  not  he  considers  himself  as  a  factor  or  as  an 
agent.  As  to  separate  books,  these  are,  of  course,  out  of 
the  question,  so  far  as  the  occasional  consignee  is  con- 
cerned. 

The  Occasional  Consignee  Theory 

^  In  connection  with  the  recording  of  the  transactions 
incident  to  the  acceptance  of  occasional  consignments  in- 
ward, there  exists  a  rather  peculiar  theory  which 
apparently  has  been  adopted  by  more  than  one  of  the 
schools  where  accounting  is  taught.  Ignoring  entirely 
the  business  of  the  factor,  as  well  as  the  statutes  which 
have  been  enacted  both  for  his  protection  and  for  that  of 
his  principals,  it  takes  the  occasional  consignee  as  a  basis, 
and  appears  to  be  satisfied  to  establish  a  philosophical  line 
of  distinction  between  what  it  calls  the  two  recognized 
methods  which  the  science  of  accounting  has  placed  at  the 
disposal  of  the  consignee  for  the  recording  of  the  trans- 
actions incident  to  his  acceptance  of  goods  on  consign- 
ment, and  to  the  sale  thereof.  The  arguments  on  which 
this  theory  rests,  are  as  follows: 

First  Argument  and  Method 

While  consigned  goods  are  not  an  asset  of  the  con- 
signee, and  do  not  raise  the  question  of  liability  until  sold, 
they  must  be  reflected  in  the  general  books  in  order  that 
all  the  facts  relating  to  the  operations  of  the  period  may 
be  recorded,  whether  they  be  financial,  historical,  or  statis- 


204      ^^^    THEORY    OF    THE    ASSET    ACCOUNTS 

tical.     To  effect  this,  the  requirements  of  the  following 
method  must  be  met : 

1.  Upon  receipt  of  consignments: 

a.  Debit  Consignment  account: 

(i)  With  the  disbursements  incurred  for 
freight,  insurance  brokerage,  etc., 
which  are  to  be  eventually  charged 
to  the  consignor. 

(2)  With  the  consigned  value  of  the  goods. 

b.  Credit  consignors  with  the  consigned  value 

of  the  goods. 

2.  As  sales  take  place : 

Debit  customers  and  credit  consignment  ac- 
count with  the  consignment  value  of  the 
goods  sold. 

3.  Monthly  (or  oftener  if  the  agreement  provided): 

a.  Credit  consignment  and  debit  consignor  with 

the  expenses  incurred  for  his  account,  as 
reflected  by  the  Consignment  account. 

b.  Debit  consignor  and  credit  Commission  ac- 

count with  commissions  earned  on  sales,  as 
per  agreement. 

c.  Debit  consignor,  and  credit  Accounts  Pay- 

able, with  the  net  amount  due  to  con- 
signors. If  the  liability  to  consignor  is 
liquidated  at  once,  debit  the  consignor, 
and  credit  Cash,  or  Notes  or  Accounts 
Payable,  as  the  case  may  be. 

d.  Credit  consignment  (old  account)  and  debit 

consignment  (new  account)  with  the  con- 
signed value  of  the  inventory  remaining  on 
hand. 

At  this  point,  the  consignment  account  and  the  con- 
signor's account  would  be  equal.     On  the  balance  sheet, 


CONSIGNMENTS— SHIPMENTS    INWARD 


205 


show  the  consigned  goods  as  an  asset,  and  the  consignor's 
account  as  a  liability. 

A  slightly  different  handling,  under  this  method,  is  to 
charge  consignors  and  credit  cash  with  the  expenses  in- 
curred for  their  account,  thus  leaving  the  consignment 
account  unaffected  by  the  charges  which  the  consignors 
have  agreed  to  meet. 

Second  Argument  and  Method 

Consigned  goods  not  being  assets  of  the  consignee, 
and  raising  no  question  of  liability  until  sold,  should  not 
be  placed  on  the  general  books.  The  data  concerning 
consignments  should  be  kept  in  memorandum  books  from 
which  the  liability  of  the  consignee  to  the  consignor  for 
goods  sold,  the  charges  to  customers,  and  the  debits  and 
credits  to  other  sundry  accounts,  can  be  abstracted 
periodically.  To  this  effect,  comply  with  the  following 
rules: 

1.  When  consignments  are  received: 

a.  In  the  general  books: 

Debit  consignment  with  freight  and  ex- 
penses, and  credit  cash  with  the  expenses 
incurred  for  the  account  of  the  con- 
signors. 

b.  In  a  memorandum  consignment  book: 

Record  the  receipt  of  the  goods,  stating  in 
appropriate  columns,  the  date  of  receipt, 
the  name  of  the  consignor,  the  consigned 
value,  and,  generally,  any  information 
which  may  be  found  useful  either  for 
purposes  of  identification  or  for  purposes 
of  bookkeeping. 

2.  When  consignments  are  sold : 

Record,   in  a   memorandum   consignments   sales 
book,  the  date  of  the  sale,  the  amount  sold, 


2o6      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

the  name  of  the  customer  to  whom  sold,  the 
amount  of  sales  returned,  the  allowances 
made  for  defective  goods,  the  name  of  the 
consignor  for  whom  sold,  and  any  other  useful 
information. 

3.  Monthly,  or  oftener  if  required: 

Prepare  from  the  memoranda  books,  and  submit 
to  the  bookkeeper,  the  following  data  which 
will  permit  him  to  journalize  the  facts  con- 
cerning consignments: 

a.  Names  of  consignors  for  whose  accounts 

sales  are  made 

b.  Names  of  customers  to  whom  goods  were 

sold 

c.  Amount  of  sales,  returns,  allowances,  etc. 

4.  From  these  facts,  and  the  data  concerning  con- 

signment expenses  and  advances,  if  any,  on  the 
general  books,  the  general  bookkeeper  prepares 
the  following  journal  entries:* 
Customers'  Controlling  Ac- 
count (say) $20,000 

To  Consignment  Freight 

Expenses  (say) $       60.00 

"    Commissions 2,000.00 

"  Accounts  Payable. . . .  17,940.00 

To  charge  the  customers  whose  names  follow, 
with  the  net  sale  price  of  consigned  goods, 
and  the  consignors  whose  names  follow,  with 
the  expenses  incurred  for  their  account  and 
the  commissions  on  the  sales,  and  to  transfer 
the  net  liability  to  consignors  to  accounts 
payable,  as  per  accounting  below  : 


In  connection  with  advances  to  consignors  a  second  journal  entry  must  be 
"^1  *'.u  "  """*  J°,*"*  debit  of  consignors,  as  appearing  in  the  accounts  pay- 
able, the  amount  of  the  account  to  which  the  advances  were  temporarily  debited 


CONSIGNMENTS— SHIPMENTS    INWARD 

Customers 


207 


Names 


Gross 
Sales 


Returns 


Allow- 
ances 


Discounts 


Net  Sales 


Creditors 


Names 


Consigrn' 
ment  No. 


Gross 

Sales 


Com- 
missions 


Freight 

and 
Expense 


Returns, 
Allow- 
ances and 
Discount 


Net  Lia- 
bility 


5.  On  the  balance  sheet,  show  neither  the  item  "Con- 
signments" nor  the  item  "Consignors." 

The  soundness  of  the  foregoing  theory  is  challenged, 
because  it  causes  the  facts  to  be  recorded  illegally,  and 
because  it  ignores  the  rights,  privileges,  and  duties  of  the 
consignee.  Why  should  a  consignee  increase  the  book 
amount  of  his  creditors'  accounts  to  the  extent  of  sales 
of  consigned  goods  sold  on  credit,  when  it  is  a  fact  that 
he  is  not  liable  for  them  until  the  customers'  accounts  are 
collected,  unless  he  has  specifically  agreed  to  hold  himself 
so  liable?  Correspondingly,  why  should  he  deliberately 
distort  the  truth  by  showing  among  his  assets,  "Cus- 
tomers* Accounts  Receivable,"  which  not  only  do  not  be- 
long to  him,  but  which  the  law  forbids  him  to  mix  with 
his  own?  Lastly,  why  should  he  expose  himself  to  ex- 
pensive and  discreditable  litigation  by  preparing  a  balance 
sheet  showing  an  item  "Cash  in  Banks"  which  contains 
moneys  to  which  he  has  no  right  whatever? 


CHAPTER  XVIII 

CONSIGNMENTS— SHIPMENTS    OUTWARD 

Accounting  Methods 

In  connection  with  the  recording  of  the  transactions 
incident  to  the  shipment  outward  of  goods  consigned,  we 
are  again  confronted  with  several  accounting  methods, 
revolving  around  the  following  hypotheses : 

1.  The  goods  consigned  outward  are  credited  at  cost 

to  the  account  with  merchandise,  and  con- 
signed at  cost. 

2.  The  goods  consigned  outward  are  credited  at  sale 

price  to  the  account  with  merchandise,  and  con- 
signed at  sale  price. 

3.  The  goods  consigned  outward  are  not  credited  to 

the  account  with  merchandise,  and  are  consigned 
either  at  cost  or  at  sale  price. 

The  object  of  the  first  method  is  to  dififerentiate  the 
gross  profits  made  by  the  concern  on  the  goods  sold  by  its 
own  organization,  from  the  profits  made  on  goods  intro- 
duced in  domestic  or  foreign  markets  through  the  medium 
of  consignees. 

The  object  of  the  second  method  is  to  treat  goods 
consigned  outward,  precisely  as  if  they  were  sold  by  the 
concern  itself,  or  held  by  it  at  inventory  times. 

The  object  of  the  third  method  may  be  the  same  as 
that  of  either  of  the  other  two,  the  distinction  being  that 
instead  of  recording  the  transactions  in  the  real  accounts 
^s  they  stand  on  the  books,  there  is  created  during  the 

208 


CONSIGNMENTS— SHIPMENTS    OUTWARD         209 

accounting  period  a  series  of  statistical  accounts  which 
appear  either  in  the  general  books  or  in  memoranda  books, 
and  permit  of  periodically  ascertaining  the  effect  of  con- 
signments upon  the  real  accounts,  as  well  as  upon  the 
income  of  the  concern. 

First  H5rpothesis 

Considering  the  first  hypothesis  and  assuming  that 
there  were  consigned  goods  worth  $1,000,  the  journal 
entry  giving  expression  to  the  facts  would  be: 

Consigned  Shipment  No.  i $1,000.00 

To  Merchandise $1,000.00 

For  cost  of  goods  consigned 
to  John  Doe,  for  sale  by 
him  subject  to  the  follow- 
ing conditions:  (Recite  con- 
ditions. ) 

Supposing,  now,  that  part  of  the  goods  consigned 
outward  had  been  sold  by  the  consignee  for  $1,000,  sub- 
ject to  commissions  of  $100,  freight  and  expenses  amount- 
ing to  $35,  and  refunds  to  customers  for  defective  goods, 
amounting  to  $15,  as  per  account  sales  rendered  by 
consignee  to  consignor,  showing  a  remittance  of  $850  and 
a  remaining  inventory  of  $500  figured  at  cost.  The  ex- 
pression of  the  above  facts  in  general  journal  form  might 
be  as  follows: 

I.  Cash $850.00 

Commissions  on  Consigned  Shipment  No.  i 100.00 

Allowances  on  Consigned  Shipment  No.  i 15.00 

Freight   and   expenses   on    Consigned    Shipment 

No.  1 35.00 

To  Consigned  Shipment  No.  i $1,000.00 

To  record  the  transactions  of  the  period  in 
connection  with  goods  consigned  outward, 
as  shown  by  the  account  sales  rendered  by 
John  Harrison. 


2IO 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


3.  Consigned  Shipment  No.  i  (new  account) $500.00 

To  Consigned   Shipment   No.    i    (old   ac- 
count)     $500.00 

To  set  up  the  inventory  as  shown  by  schedule 
attached  to  account  sales  rendered  this  day 
by  consignee. 

3.  Consigned  Shipment  No.  i $500.00 

To  Profit  and  Loss $500.00 

For  gross  profit  on  sales  of  goods  consigned 
outward. 

4.  Profit  and  Loss $150.00 

To  Commissions  on  Consigned   Shipment 

No.  I $ioaoo 

"    Allowances    on    Consigned    Shipment 

No.  1 15.00 

"    Freight  and  Expenses  on  Consigned 

Shipment  No.  i 35-00 

To  close  into  the  Profit  and  Loss  account  the 
expenses  incident  to  consigned  shipments, 
and  the  allowances  on  defective  goods. 

After  the  foregoing  entries  have  been  posted,  the 
status  of  the  account  "Consigned  Shipment  No.  i"  is  as 
follows: 

Consigned  Shipment  No.  i 


Merchandise  (cost)  . . . 
Profit  and  Loss 

...$1,000.00 
500.00 

Sundry  

Inventory   (cost)  . . . . 

$1,000.00 

500.00 

$1,500.00 

$1,500.00 

Inventory   (cost) 

. . .     500.00 

Thus,  we  see  that  the  purpose  of  this  method  is  ful- 
filled through  the  raising  of  an  account  which  will  separate 
the  goods  consigned  from  the  merchandise  to  be  sold  by 
the  concern  itself,  and  subsequently  record  only  such 
transactions  as  contribute  to  the  gross  profit  on  sales, 
either  in  a  positive  or  in  a  negative  manner.  As  to  the 
expenses  and  losses  incurred  as  a  result  of  the  consign- 


CONSIGNMENTS— SHIPMENTS    OUTWARD  21I 

ment,  they  were  recorded  in  properly  earmarked  nominal 
accounts  which  will  eventually  be  closed  into  Profit  and 
Loss,  where  they  will  be  opposed  to  the  gross  profit  on 
consignments,  in  order  that  the  selling  profit  thereon  may 
be  ascertained. 

Second  H5rpothesis 

Under  the  second  hypothesis  the  goods  consigned  out- 
ward are  credited  at  sale  price  to  the  account  with 
merchandise  and  consigned  at  sale  price.  Let  us  consider 
the  case  of  goods  costing  $1,000,  consigned  outward  at 
their  sale  price  of  $1,500,  subject  to  a  commission  of  10% 
on  the  sale  price.  In  due  course,  the  consignee  renders 
an  account  sales  showing  that  he  has  sold  goods  to  the 
amount  of  $1,000,  and  submits  an  inventory  showing  that 
he  still  has  on  hand  goods  worth,  at  sale  price,  $500.  He 
claims  allowances  of  $15  refunded  to  customers  on  ac- 
count of  defective  goods,  and  freight  and  expenses  of  $35, 
both  of  which  the  consignor  must  stand;  he  also  takes 
credit  for  his  commission  and  for  his  cash  remittance. 

The  entries  necessary  to  record  these  transactions  on 
the  books  of  the  consignor  might  be  expressed  in  general 
journal  form: 

1.  Consigned  Shipment  No.  i $1,500.00 

To  Merchandise $1,500.00 

For  $1,000  worth  of  goods  consigned  at  sale 
price  to  John  Harrison,  consignee. 

2.  Cash  (Consignee  No.  i ) $850.00 

Commissions  on  Consigned  Shipment  No.  i 100.00 

Allowances  on  Consigned  Shipment  No.  i I5.0O 

Freight  and  expenses  on  Consigned  Shipment 

No.    1 35-00 

To  Consigned  Shipment  No.  1 $1,000.00 

To  record  the  transactions  of  the  period  in 
connection  with  goods  consigned  outward, 
as  shown  by  account  sales  rendered  by 
John  Harrison. 


212 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


3.  Consigned  Shipment  No.  i  (new  account) $soaoo 

To  Consigned  Shipment  No.  i    (old  ac- 
count)    $Soaoo 

To  set  up  inventory,  as  shown  by  schedule 
attached  to  account  sales  rendered  this 
day  by  consignee,  John  Harrison. 

4.  Profit  and  Loss $    150.00 

To  Commissions  on  Consigned  Shipment 

No.  I $100.00 

"   Allowances   on    Consigned    Shipment 

No.  1 15.00 

"    Freight  and  Expenses  on  Consigned 

Shipment  No.  i 35-00 

To  close. 


At  this  point,  the  status  of  Consigned  Shipment  Ac- 
count No.  I  would  be : 

Consigned  Shipment  No.  i 


Merchandise  (sale  price)  .$i,5oaoo 


$1,500.00 


Sundry $1,000.00 

Inventory 500.00 


$1,500.00 


Inventory 500.00 

while  the  status  of  the  account  with  merchandise  would  be: 
Merchandise 


Purchases   (say) $20,000.00 


Sales — Concern   (say)..  .$10,000.00 
Sales — Consignee  (Ship- 
ment No,  I.) 1,500.00 


If,  in  the  above  example,  all  the  goods  consigned  had 
been  sold  at  the  end  of  the  accounting  period,  it  would 
appear  that  the  method  of  handling  consignments  had 
adequately  fulfilled  its  purpose.  But  since  all  the  goods 
have   not  been   sold,   and   since,    further,   the   consignor 


CONSIGNMENTS— SHIPMENTS    OUTWARD 


213 


wishes  to  close  his  books  and  ascertain  his  profit,  it  is 
necessary  to  temporarily  relieve  the  merchandise  account 
of  the  gross  profit  on  goods  consigned  outward,  which 
was  included  in  the  account  at  the  time  of  the  consign- 
ment. This  is  done  by  means  of  the  following  journal 
entry: 

Merchandise   $5CX).oo 

To  Consigned  Shipment  No.  i  $500.00 

To  send  back  to  the  former  ac- 
count, at  the  value  at  which  it 
was  formerly  credited  thereto, 
the  remaining  inventory  of 
goods  shipped  outward  on  con- 
signments. 

As  soon  as  the  profit  of  the  period  is  ascertained,  the 
above  entry  is  reversed. 

Third  Hypothesis 

Under  the  third  hypothesis,  goods  consigned  outward 
are  not  credited  to  the  account  with  merchandise,  and 
are  consigned  either  at  cost  or  at  sale  price.  Two  methods 
of  recording  are  available. 

First  Method 

I.  If  goods  are  consigned  at  cost  price,  record  the 
material  facts  relating  to  the  consignments  outward,  as 
follows : 

a.  When  shipping  goods  on  consignment: 


Debit  Consignee 

No.— 
Credit  Consigned 

Shipment  No.  - 


with    cost    of    the    goods 
shipped. 


214      THE    THEORY    OF    THE    ASSET    ACCOUNTS 


b.  When  consignee  renders  account  sales: 
(i)    Debit  Profit  and  " 
Loss 
Credit    Consignee 
No.  — 


with  the  commissions,  ex- 
penses, and  allowances. 


(2)  Debit     Consignee 

No.  — 
Credit  Profit  and 
Loss 

(3)  Debit  Cash 
Credit    Consignee 

No.  — 

(4)  Debit     Consigned 

Shipment 
No.  — 
Credit     Merchan- 
dise 


with  gross  profit  on  sales  as 
reported  and  collected. 


with    remittances    on    ac- 
count of  collected  sales. 


with  the  cost  price  of  goods 
sold  on  consignment. 


2.  If  goods  are  consigned  at  sales  price,  record  the 
facts  relating  to  consignments  outward  as  follows:  , 

a.  When  shipping  goods  on  consignment: 


Debit  Consignee 

No.  — 
Credit  Consigned 

Shipment  No.  — 


with  the  sales  price  of  goods 
consigned. 


b.  After  consignee  has  rendered  account  sales: 


(i)   Debit  Profit  and 
Loss 
Credit    Consignee 
No. — 


with  commissions,  expenses, 
and  allowances. 


CONSIGNMENTS— SHIPMENTS    OUTWARD 


215 


(2)  Debit     Consigned 

Shipment 
No.— 

Credit: 

(a)  Merchan- 

dise 

(b)  The    Profit 

and  Loss 
Account 

(3)  Debit  Cash 
Credit    Consignee 

No.  — 


with     proceeds    of    goods 
sold. 


with  the  cost  of  the  con- 
signed goods  sold  for  cash. 


with  the  gross  profit  on  the 
sales  of  consigned  goods. 


with  remittance. 


To  illustrate  this  first  method  available  under  the 
third  hypothesis,  let  us  assume  that  goods  costing  $2,000 
have  been  consigned  to  John  Harrison,  (i)  at  cost,  (2)  at 
sale  price,  and  that,  in  either  case,  the  consignee  has  sold 
a  certain  amount  of  goods  the  cost  of  which  was  $1,000 
to  the  consignor.  The  consignee  renders  an  account  sales, 
deducting  from  his  remittance  10%  for  commissions  on 
gross  sales,  $35  for  allowances  to  customers,  and  $75  for 
expenses  paid  by  him  for  the  account  of  the  principal. 

The  ledger  accounts  of  the  consignor,  as  affected  by 
both  assumptions  will  be: 

Example  No.  i 

(Ledger  accounts  of  the  consignor,  as  affected  by  the  recording  of  the 
transactions  incident  to  the  consignment  of  goods  at  cost,  and  to  the 
partial  sale  thereof  by  the  consignee.) 

Consignee  No.  i — J.  Harrison 


Consigned  Shipment  No. 
I $2,000.00 


Profit    and    Loss — Com- 
missions  $   150.00 


2i6      THE    THEORY    OF    THE    ASSET    ACCOUNTS 
Consignee  No.  i — ^J.  Harrison — Continued 


Profit  and  Loss — Excess 
of  sale  price  over  cost, 
on  sale  of  consigned 
goods,  i.  e.,  gross  profit 
on  sales 500.00 


$2,500.00 


Profit  and  Loss — Allow- 
ances         35.00 

Profit  and  Loss  —  Ex- 
penses         75.00 

Cash — Remittance 1,240.00 

Balance 1,000.00 


$2,500.00 


Balance   $1,000.00 

Consigned  Shipment  No.  i 


Merchandise      (Cost     of 

Consignments  sold)..  ..$1,000.00 
Balance 1,000.00 


$2,000.00 


Consignee  No.  i $2,000.00 


Balance 
Cash 


$2,000.00 
.$1,000.00 


Consignee  No.  i $1,240.00 


Profit  and  Loss 


Consignee  No.  i — 

Consignee     No.     i — Gross 

Commission,  Consign- 

Profit  on  Consigned  Ship- 

ment No.  i $150.00 

ment  No.  I $500.00 

Allowances  on  Consign- 

ment No.  1 35.00 

Expenses    on    Consign- 

ment No.  i 75.00 

Merchandise 


Purchases — say :  $10,000.00 


Sales  by  the  concern  itself, 

say:    $6,000.00 

Consigned  Shipment  No. 
I — Cost  of  goods  con- 
signed and  sold,  gross 
profit  on  which  is  re- 
corded in  the  Profit  and 
Loss  account i,ooaoo 


CONSIGNMENTS— SHIPMENTS    OUTWARD 


217 


Example  No.  2 

(Ledger  accounts  of  the  consignor,  as  affected  by  the  recording  of  the 
transactions  incident  to  the  consignment  of  goods  at  sale  price,  and  to 
the  partial  sale  thereof  by  the  consignee.) 

Consignee  No.  i — ^John  Harrison 


Consigned  Shipment  No. 
I $3,000.00 


$3,000.00 


Profit  and  Loss — Com- 
missions   $    150.00 

Profit  and  Loss — Allow- 
ances        35.00 

Profit  and  Loss  —  Ex- 
penses         75.00 

Cash — Remittance 1,240.00 

Balance    1,500.00 


3,000.00 


Balance $1,500.00 

Consigned  Shipment  No.  i 


Merchandise $1,000.00 

Profit    and    Loss — Gross 

Profit   500.00 

Balance 1,500.00 


$3,000.00 


Consignee  No.  i $3,000.00 


Balance 

Cash 


$3,000.00 
.$1,500.00 


Consignee  No.  i $1^40.00 


Profit  and  Loss 


Consignee  No.  i- 
Commissions  . 
Allowances  ... 
Expenses   .... 


.$150.00 
.  35.00 
.     75-00 

Merchandise 


Consigned  Shipment  No.  i.$5oaoo 


Purchases — say:  $10,000.00 


Sales  by  the  concern, 
say :  $6,000.00 

Consigned  Shipment  No. 
I  1,000.00 


2i8      THE    THEORY    OF    THE    ASSET    ACCOUNTS 


CONSIGNMENTS— SHIPMENTS    OUTWARD 


219 


After  the  accounts  are  closed  as  shown  in  the  fore- 
going examples,  the  account  of  the  consignee  and  the 
account  with  consigned  shipment  are  purely  statistical, 
and  have  no  place  on  the  balance  sheet. 

Second  Method 

I.  If  goods  are  consigned  at  cost: 

a.  When  shipping: 

Record  the  facts  relating  to  consignments  in  a 
memorandum  book,  as  per  example  on  page 
218,  and  make  no  entry  whatever  in  the  general 
books. 

b.  After  receipt  of  account  sales: 

Record  the  facts  contained  therein,  in  the 
memorandum  consigned  shipments  book,  as 
per  example  in  Figure  37. 

c.  At  any  time  during  the  accounting  period,  using 

the  data  furnished  by  the  memorandum  book, 
make  in  the  journal  and  in  the  cash  book  the 
entries  expressed  here  in  general  journal  form : 

Cash    $850.00 

Commissions — Consigned    Shipment 

No.  1 100.00 

Freight  and  Expense  on  Consigned 

Shipment  No.  i 35-00 

Allowances  to  Customers   on  Con- 
signed Shipment  No.  i 15.00 

To  Merchandise $500.00 

"    Profit  and  Loss $500.00 

To  record  the  transactions  of 
the  period  concerning  con- 
signment No.  I,  in  so  far  as 
they  have  affected  the  assets 


220      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

and  the  income,  as  per  ac- 
count sales  No. received 

this  day  from  Consignee  No. 
I,    and    as    reflected   by   the 
memorandum  consigned  ship- 
ments  book.     The   amount 
credited    to    merchandise    is 
the  cost  of  the  goods  sold. 
2.  If  the  goods  are  consigned  at  sales  price,  plan  the 
memorandum  consigned  shipments  book  in  such  a  manner 
that  the  cost  of  the  goods  will  be  opposed  to  the  sale 
price,  as  well  when  they  are  consigned  as  when  they  are 
sold.     The  journal  entry  to  be  made  at   the  time  the 
account  sales  is  rendered,  is  identical  in  every  respect 
with  the  above. 

Before  leaving  the  subject  of  consignments,  it  may 
be  well  to  state  that  since  the  consignee  is  not  liable  for 
uncollected  sales  unless  he  has  agreed  to  hold  himself  so 
liable,  the  consignor  should  not  consider  as  sales  what 
has  been  sold  on  credit.  Unless  this  be  done,  there  will 
exist  no  harmony  whatever  between  the  books  of  the 
principal  and  of  the  agent;  the  books  of  the  consignor 
will  show  that  he  has  a  claim  against  the  consignee, 
whereas  the  latter's  books  will  lail  to  reflect  a  liability 
therefor. 


CHAPTER  XIX 
LAND   AND    BUILDINGS 

Distinction  Between  "Land"  and  "Buildings" 

To  the  average  layman,  there  is  no  difference  between 
the  two  elements  of  the  account  "Land  and  Buildings." 
Giving  as  his  authority  the  common  law,  which  made  the 
term  "real"  apply  to  land,  tenements,  and  hereditaments, 
he  is  satisfied  to  call  both  real  estate.  The  courts  do  not 
usually  attempt  to  differentiate  the  two  terms,  except  in 
special  cases,  as  that  of  Truesdell  v.  Gay,*  where  the 
court,  referring  to  the  word  "building,"  seemed  to  be  of 
the  opinion  that,  taken  in  its  broadest  sense,  it  could  not 
be  made  to  apply  to  such  erections  on  land  as  fences, 
gates,  and  other  such  structures.  The  accountant,  how- 
ever, must  often  draw  a  very  sharp  line  not  only  between 
the  two  values,  land  and  buildings,  but  as  well,  between 
that  part  of  the  land  which  is  necessary  to  the  proper 
working  of  the  plant,  and  that  part  which  could  be  sold 
without  in  any  way  interfering  with  its  operations. 

The  components  of  the  cost  of  plant  land  vary 
materially  from  those  of  investment  land;  the  considera- 
tion of  increases  in  market  values,  while  of  much  im- 
portance in  the  case  of  the  latter,  is  merely  an  incident  in 
the  case  of  the  former,  since  the  asset  cannot  ordinarily 
be  sold  without  causing  operations  to  come  to  an  end,  at 
least  temporarily.  On  the  other  hand,  buildings  de- 
preciate  through  wear  and   tear,   while  land   does  not; 


•13  Gray  (Mass.),  311,  312. 

221 


222 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


hence,  if  reserves  are  created  for  the  depreciation  of  build- 
ings, and  applied  for  balance  sheet  purposes  to  Land  and 
Buildings  account,  it  is  not  possible  to  ascertain  the  book 
value  of  the  asset  which  the  depreciation  afifects. 

These  accounting  differences  in  the  nature  of  the  two 
values,  land  and  buildings,  would  seem  to  be  sufficient  to 
cause  the  creation  of  two  distinct  accounts  with  them,  and 
are  generally  so  regarded. 

Plant  Land 

That  part  of  the  land  which  the  buildings  occupy,  or 
which  is  necessary  to  the  proper  working  of  the  plant, 
should  be  kept  by  itself  in  the  account  "Plant  Land." 

As  part  of  the  plant,  land  may  be  charged  at  the  time 
of  acquisition,  not  only  with  the  cost  of  purchase,  but 
with  all  the  expenses  incident  thereto,  such  as  title  search- 
ing and  insuring,  commissions  to  real  estate  agents, 
recording  of  deeds,  etc.  After  it  has  been  acquired,  and 
until  operations  have  begun,  it  can  be  charged  with  in- 
terest on  the  purchase-money  mortgage  (or  on  any  other 
obligation  incurred  in  its  acquisition)  and  with  the  cost 
of  fencing,  erecting  gates  and  approaches,  filling  in, 
draining,  leveling,  etc.,  incident  to  the  erection  of  the 
plant.  As  soon,  however,  as  the  plant  has  begun  opera- 
tions, the  value  of  plant  land  can  only  be  increased  by 
the  cost  of  such  improvements  as  enhance  the  efficiency  of 
the  buildings  erected  thereon,  or  increase  their  useful  life 
by  remedying  conditions  which  tend  to  make  structures 
deteriorate  faster  than  might  reasonably  be  expected. 

The  question  of  cost  of  improvements  which  tend  to 
make  plant  land  more  valuable  for  any  purpose  other 
than  the  one  for  which  it  was  acquired,  while  admittedly 
important  in  determining  its  cost  if  a  sale  is  contemplated, 
should  not  be  permitted  to  influence  the  appraisal  of 
values  for  the  purposes  of  a  going  concern. 


LAND    AND    BUILDINGS 


223 


Investment  in  Lands 

Any  parcel  of  land  owned  and  not  at  present  neces- 
sary to,  and  not  likely  to  be  required  for,  the  operations 
of  the  plant,  is  essentially  an  investment.  The  true  rea- 
son for  acquiring  it  may  not  have  been  a  desire  for  profits. 
It  may  be  that  in  order  to  obtain  a  desirable  plot  it  was 
necessary  to  purchase  adjoining  land  which  had  no  special 
value  for  the  purpose  of  the  plant;  or  it  may  be  that  the 
purchase  was  made  with  a  view  of  preventing  the  erec- 
tion in  the  immediate  neighborhood  of  competing  or 
light-obstructing  plants;  whatever  the  reason,  a  certain 
amount  of  capital  has  been  used  for  the  acquisition  of  a 
value  not  required  for  operating,  and  the  cost  of  carrying 
it  may  properly  include  betterments,  maintenance  of 
fencing,  taxes,  interest  on  the  purchase-money  mortgage, 
etc.,  even  after  operations  have  begun. 

Buildings 

The  Buildings  account  is  capable  of  apparently  har- 
monious action,  even  though  elements  which  are  really 
foreign  to  it  are  introduced  in  its  make-up.  Therein  lie 
both  its  importance  and  its  danger. 

If  we  were  to  attempt  to  inject  into  the  account  with 
customers,  transactions  which  have  no  relation  whatever 
with  sales  and  settlements  thereof,  we  would  obtain  re- 
sults which,  by  comparison  with  others,  would  carry  on 
their  face  the  evidence  of  inaccuracy.  If,  on  the  other 
hand,  we  were  to  include  on  either  side  of  the  account 
with  merchandise,  elements  of  cost  and  elements  of  deduc- 
tion from  cost  which  have  no  relation  whatever  with  mer- 
chandise, we  would  distort  the  truth  about  certain  phases 
of  the  profits,  but  we  would  not  change  the  net  result  of 
the  operations  of  the  period. 

In  the  case  of  buildings,  however,  the  situation  is 
quite  different.     The  account  offers  the  opportunity  of 


224      '^^^    THEORY    OF    THE    ASSET    ACCOUNTS 

capitalizing  expenditures  in  order  that  the  profits  of  the 
period  may  be  inflated,  or  of  reducing  the  income  by 
charging  to  revenue  the  cost  of  adding  to,  or  enlarging, 
the  structures,  as  well  as  the  cost  of  extending  their  useful 
life,  which  should  have  been  capitalized.  That  concerns 
have  frequently  taken  advantage  of  that  opportunity  is 
not  to  be  doubted;  that  it  can  be  done  successfully  and,  it 
may  be  said,  without  much  danger,  is  due  to  the  fact  that 
the  standards  by  which  the  components  of  the  Buildings 
account  (in  common  with  all  other  so-called  property  ac- 
counts) are  judged,  may  be  stretched  to  accommodate  any 
personal  opinion  not  too  grossly  unreasonable. 

The  original  cost  of  the  buildings  is  seldom  a  question 
at  issue  so  far  as  the  accountant  is  concerned.  If  the 
buildings  have  been  acquired  from  another  concern,  he 
is  not  competent  to  pass  judgment  upon  the  price  paid 
for  them ;  nor  is  he  asked  to  do  so.  All  he  has  to  do  is  to 
record  the  transaction.  If  the  buildings  have  been  erected 
under  a  contract,  the  situation  is  precisely  the  same;  if 
they  have  been  constructed  by  the  concern  itself  under  a 
special  contract  calling  for  the  payment  to  the  builder  of 
a  certain  percentage  of  the  cost,  the  true  cost  of  the  build- 
ings will,  of  course,  be  whatever  has  been  expended  under 
the  direction  of  the  builder,  plus  the  fees  paid  to  him  as 
per  contract.  In  this  latter  case  the  interest  on  the  money 
which  the  concern  may  have  had  to  borrow  pending  con- 
struction, in  order  to  meet  the  bills  of  the  builder,  will  also 
be  considered  as  a  proper  cost  of  the  structures.  Lastly, 
if  the  construction  is  attended  to  by  the  concern  itself, 
upon  plans  submitted  by  an  architect,  the  cost  of  the 
building  will  include  his  fees,  the  expenses  incurred  in 
connection  with  permits,  licenses,  etc.,  the  cost  of  in- 
surance protection,  the  cost  of  all  material  used,  the  cost 
of  the  labor  expended  on  the  foundations  as  well  as  on 
the  structures,  the  cost  of  any  outside  labor  which  may 


LAND    AND    BUILDINGS 


225 


have  been  required,  the  proportion  of  the  overhead  ex- 
penses which  apply  to  the  construction,  the  interest  on 
any  moneys  which  have  been  borrowed  for  construction 
purposes  and  used  therefor,  up  to  the  time  when  the  new 
buildings  were  opened  for  operation. 

In  regard  to  what  constitutes  the  cost  of  material,  sup- 
plies, and  labor  consumed  in  construction,  the  rulings  of 
the  Public  Service  Commission  are  of  interest  to  all  con- 
cerns, whether  or  not  they  fall  under  the  class  of  business 
organizations  which  the  commission  controls,  for  they 
embody  the  views  which  accountants  generally  hold  on 
the  subject. 

"Cost  of  labor  (employed  in  construction)  includes  not 
only  wages,  salaries,  and  fees  paid  employees,  but  also 
such  personal  expenses  of  employees  as  are  borne  by  the 
corporation.  Cost  of  materials  and  supplies  consumed  in 
construction,  is  the  cost  at  the  places  where  they  enter 
into  construction,  including  cost  of  transportation  and 
inspection  when  specifically  assignable.  If  such  materials 
and  supplies  are  passed  through  storehouses,  their  cost  as 
entered  in  the  account  may  include  a  certain  proportion 
of  store  expenses." 

It  is  an  open  question  as  to  whether  or  not  it  is  proper 
to  add  to  the  overhead  expenses  applicable  to  construc- 
tion, an  extra  amount  representing  the  profit  which  a  con- 
tractor would  have  added  to  the  price  quoted  for  the 
buildings.  It  is  claimed  by  some  that  the  cost  of  the 
buildings  constructed  by  a  concern  for  itself,  presumably 
because  it  can  erect  them  at  better  terms  than  would  be 
possible  if  the  work  were  given  to  contractors,  shoulfl  be 
such  as  to  reflect  the  saving  realized  by  the  company.  It 
is  claimed  by  others  that  the  cost  to  the  company  may 
be  stated  at  a  figure  representing  precisely  what  it  would 
have  had  to  pay  if  outsiders  had  attended  to  the  con- 
struction.    This  latter  theory  may  appeal  to  the  statis- 


226      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

tician  and  to  the  independent  appraiser,  but  its  effect 
upon  the  results  of  the  operations  is  so  marked  as  to  be 
obnoxious  to  the  accountant.  Assuming,  for  instance, 
that  a  company  were  to  build  an  additional  plant  during  a 
certain  operating  period,  and  add  to  the  cost  of  the  build- 
ing an  amount  of  overhead  expenses  calculated  to  cover 
not  only  the  proper  proportion  which  the  work  performed 
would  naturally  warrant,  but,  as  well,  the  profits  which  a 
contractor  would  have  realized  on  the  work,  it  stands  to 
reason  that  the  results  of  the  operations  of  that  period 
may  show  improvements  over  past  periods  which  disturb 
comparisons  and  lead  to  erroneous  judgment  of  condi- 
tions in  regard  to  carrying  capacity. 

After  the  original  cost  of  buildings  has  been  recorded, 
all  subsequent  charges  to  the  account  raise  the  ever- 
present  and  delicate  question  of  the  proper  separation  of 
capital  expenditures  and  revenue  expenditures. 

Capital  Expenditures 

When  subjected  to  a  theoretic  analysis,  this  term  ap- 
pears to  apply  to  such  expenses  as,  in  the  aggregate,  rep- 
resent the  cost  of  the  increased  earning  capacity  of  the 
enterprise  as  a  whole  or  of  particular  parts  thereof,  which 
has  been  secured  over  the  earning  capacity  known  to 
exist  before  the  said  expenses  were  incurred. 

Revenue  Expenditures 

In  contradistinction,  these  expenses  are  such  as  must 
be  incurred  in  order  that  advantage  may  be  taken  of  the 
earning  capacity  of  the  enterprise,  or  in  order  that  such 
capacity  may  be  maintained  at  the  required  standard. 

If  the  radius  of  action  of  a  locomotive  is  200  miles  on 
a  certain  amount  of  fuel,  water,  and  lubricants,  and,  if 
through  the  addition  of,  say,  a  steam  condenser  to  the 
mechanical  equipment  of  the  engine,  that  radius  is  ex- 


LAND    AND    BUILDINGS 


2,2^ 


tended  to  250  miles  on  the  same  consumption  of  fuel, 
water,  and  lubricants,  it  is  obvious  that  the  value  of  a 
capital  asset  has  been  enhanced  as  an  income  producer, 
and  that  the  cost  of  the  increased  earning  power  may  be 
capitalized.  But  if,  on  the  other  hand,  the  additional 
equipment  of  the  machine  has  only  resulted  in  maintain- 
ing an  efficiency  which  would  otherwise  have  been  im- 
paired, there  has  been  incurred  an  expense  necessary  to 
obtain  revenue,  that  is  to  say,  a  revenue  expenditure. 

Writing  on  the  subject  of  'The  Accounting  of  Indus- 
trial Enterprises,"*  William  M.  Lybrand,  C.P.A.,  says: 
"With  respect  to  items  which  may  properly  be  considered 
as  capital  expenditures,  it  has  been  suggested  as  a  work- 
ing basis  that  no  addition  should  be  made  to  the  property 
accounts  unless  it  can  be  clearly  shown  that  they  have 
increased  the  earning  capacity  of  the  plant.  A  simple, 
positive  rule  such  as  this  might  be  all  that  is  required,  if 
the  changes  in  the  plant  and  the  resulting  increase  in 
earning  capacity  were  occasioned  only  by  actual  exten- 
sions or  additions  of  property  which  had  never  before  ex- 
isted. But  such  is  not  the  case.  In  every  progressive 
manufacturing  concern,  alterations  or  additions  to  the 
plant  are  constantly  being  made  for  the  purpose  of  sim- 
plifying the  manufacturing  processes  and  thereby  increas- 
ing the  output  with  the  same  expenditure  for  labor  and 
materials,  or  in  order  to  decrease  those  operating  charges 
which  are  in  the  nature  of  overhead  expenses  required  to 
be  taken  up  in  the  cost  of  the  product.  As  no  alteration 
or  addition  to  the  plant  is  probably  ever  undertaken  ex- 
cept for  the  purpose  of  increasing  the  earning  capacity 
thereof,  directly  or  indirectly,  the  literal  application  of  the 
rule  referred  to  is  not  possible,  and  it  will  be  necessary  to 
consider  the  nature  of  the  various  alterations,  improve- 
ments, and  additions,  before  an  intelligent  decision  can  be 
made  as  to  their  ultimate  disposition." 

*  Journal  of  4fcpuntffncy,  December,  1908, 


228      1'HE    THEORY    OF    THE    ASSET    ACCOUNTS 

In  the  Journal  of  Accountancy  of  November,  1906, 
John  P.  Herr  says  on  the  same  subject: 

"One  of  the  most  difficult  things  with  which  the  ac- 
countant has  to  deal  is  the  question  of  capital  expendi- 
tures *  *  *  As  capital  expenditures  are  generally 
handled  at  the  present  time,  a  manager  who  has  interest 
in  the  profits  *  *  *  may  cover  up  shrinkages  in  the  net 
earnings,  losses  by  bad  management,  and  defalcations,  and 
make  it  practically  impossible  for  the  accountant  *  *  * 
to  determine  whether  the  charges  are  for  bona  fide  bet- 
terments or  not  *  *  *  We  find  in  one  work  on  account- 
ing a  statement  that  when  in  doubt  as  to  whether  an 
expenditure  is  a  capital  expenditure  or  chargeable  against 
revenue,  the  amount  should  be  charged  against  capital, 
the  reason  given  being  that  if  it  is  'afterwards'  determined 
that  the  expenditures  were  for  repairs,  it  is  easy  to  get 
them  out  of  capital  into  revenue,  while  it  is  extremely 
difficult  without  much  explanation  and  on  proper  author- 
ity to  take  items  out  of  revenue  and  place  them  into 
capital.  The  adoption  of  such  a  policy  by  accountants 
will  add  to  the  already  great  laxity  in  this  direction,  and 
tend  towards  the  lowering  of  professional  standards." 

As  bearing  upon  the  subject  of  capital  expenditures, 
the  following  quotations  from  a  pamphlet  issued  by  the 
Public  Service  Commission,  First  District,  State  of  New 
York,  may  be  of  interest: 

Additions.  "Additions  include  additional  structures, 
facilities,  or  equipment  not  taking  the  place  of  anything 
previously  existing." 

Betterments.  "Betterments  include  the  enlargement 
or  improvement  of  existing  structures,  facilities,  and 
equipment." 

Renewals.  "Renewals  include  all  extensions  of  terms 
of  years  in  land  and  tangible  fixed  capital,  and  all  exten- 


LAND    AND    BUILDINGS 


229 


sions  of  the  life  period  of  franchises  and  other  intangible 
fixed  capital." 

Replacements.  ''Replacements  include  all  substitu- 
tions for  capital  exhausted  or  become  inadequate  in 
service,  the  substitutes  having  substantially  no  greater 
capacity  than  the  things  for  which  they  were  substituted. 
When  a  substitute  has  a  substantially  greater  capacity 
than  that  for  which  it  is  substituted,  the  cost  of  substitu- 
tion of  one  of  the  same  capacity  as  the  thing  replaced 
should  be  charged  as  a  replacement,  and  the  remaining 
portion  of  the  cost  of  the  actual  substitute  should  be 
charged  as  a  betterment." 

Repairs.  "When  through  wear  and  tear  or  through 
casualty  it  becomes  necessary  to  replace  some  part  of  any 
structure,  facility,  or  unit  of  equipment,  and  the  extent  of 
such  replacement  does  not  amount  to  a  substantial  change 
of  identity  in  such  structure,  facility,  or  unit  of  equipment, 
the  replacement  of  such  part  is  to  be  considered  a  repair, 
and  the  cost  of  such  repair  is  to  be  treated  as  an  operating 
expense,  and  must  not  be  charged  as  a  replacement  in  any 
capital  account." 

In  connection  with  land  and  buildings  there  often 
arises  the  question  of  increased  valuation  due  to  favorable 
conditions  in  the  real  estate  market.  Concerns  desiring 
to  make  a  good  showing  for  a  given  period,  are  not  un- 
likely to  take  advantage  of  upward  fluctuations  of  land, 
in  order  to  inflate  their  "profits."  The  accountant  is  very 
likely  to  have  in  connection  with  this  kind  of  profits  the 
same  opinion  as  the  average  lawyer  has  about  all  kinds  of 
gains.  To  the  lawyer,  nothing  is  profit  which  has  not 
been  realized  in  cash.  To  the  accountant,  nothing  brings 
profits  which  has  not  been  sold.  He  instinctively  objects 
to  all  kinds  of  estimates  and  inflations  of  capital  assets  on 
the  basis  of  market  values.  He  is  inclined  to  think  that 
since  business  requires  its  capital  assets  in  order  to  oper- 


230      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

ate,  it  cannot  aflFord  to  sell  them;  hence,  the  taking  of 
profits  on  values  supposed  to  be  invested  permanently, 
might  well  be  deferred  until  they  are  sold,  either  because 
operations  have  come  to  an  end  or  because  more  favorable 
conditions  elsewhere  have  made  advisable  the  removal  of  the 
plant. 


CHAPTER  XX 

BUILDING   EQUIPMENT,    FURNITURE   AND 

FIXTURES,     DELIVERY     EQUIPMENT, 

PATTERNS,   OTHER  EQUIPMENT 

Realty  Fixtures  and  Personalty  Fixtures 

The  question  of  the  proper  differentiation  of  realty  fix- 
tures and  personalty  fixtures  is  of  interest  to  accountants, 
since  it  involves  the  possibility  of  lawsuits  in  connection  with 
the  foreclosure  of  mortgages  on  buildings  and  on  their 
equipment,  the  rights  of  the  parties  to  a  contract  of  sale  of 
realty,  the  rights  of  the  landlord  and  of  the  tenant,  and  the 
important  matter  of  accurate  accounting  in  connection  with 
bankruptcy  proceedings  and  receiverships. 

Realty  fixtures  are  part  of  the  building  to  which  they 
are  annexed,  and  their  value  should  either  be  added  to  the 
value  of  the  building,  or  stated  in  a  separate  account  with 
building  equipment,  or  in  a  group  of  accounts  representing 
that  equipment.  Personalty  fixtures  are  neither  part  of  the 
building  nor  of  its  equipment;  they  are  not  considered  as 
part  of  the  property  pledged  under  a  mortgage,  and  they  can 
be  sold,  removed,  changed,  destroyed,  or  otherwise  disposed 
of,  without  in  any  way  affecting  the  value  of  the  building  or 
the  rights  of  any  one  who  has,  or  may  have,  an  interest  in 
the  structure. 

Realty  fixtures  may,  under  certain  conditions,  include 
elements  which  accountants  are  sometimes  satisfied  to  call 
'"machinery"  or  "machinery  and  tools."  When  such  is  the 
case,  what  is  the  worth  of  the  information  supplied  by  books 

231 


232      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

of  account  which  state  the  value  of  the  asset  "buildings," 
in  the  narrow  sense  which  the  word  may  have,  and  oppose  it 
to  a  liability  account  reflecting  the  mortgage  which  has  been 
placed  not  only  on  the  structure,  but,  as  well,  on  all  that  it 
contains  which  falls  under  the  meaning  of  the  term  "realty 
fixtures"  as  the  law  understands  it  ? 

Going  a  little  further,  what  is  the  value  of  a  statement  of 
affairs  which  deducts  from  the  amount  expected  to  be 
realized  on  buildings,  the  amount  of  the  mortgage  placed 
thereon,  if  part  of  the  value  of  the  said  building  is  to  be 
found  in  the  account  "Machinery  and  Tools"  ? 

The  Law  of  Fixtures 

The  Cyclopaedia  of  Law  and  Procedure  states  that 
"the  law  of  fixtures  deals  with  property  whose  status  as 
realty  or  personalty  is  indeterminate  until  the  proof  of  cer- 
tain facts  and  the  application  of  certain  rules  of  law.  When 
the  status  is  thus  determined,  tangible  property  must  be 
either  real  or  personal.  Fixtures  then  may  be  defined  as 
tangible  property  whose  status  as  realty  or  personalty  is 
indeterminate.  According  as  certain  facts  shall  appear,  its 
status  will  become  determinate,  and  it  will  fall  into  one  or  the 
other  category  *  *  *  in  the  matter  of  "fixtures"  so 
called,  it  is  difficult  to  say  with  precision  what  degree  of 
annexation  is  sufficient  to  work  the  change  from  personalty 
to  realty.  In  some  cases  the  courts  have  said  as  a  matter 
of  law,  that  certain  articles,  although  fastened  to  the  realty, 
are  no  part  of  it,  while  on  the  other  hand  articles  may  be  so 
incorporated  with  realty  that  the  court  will  say  as  a  matter 
of  law  that  they  are  fixtures ;  but  as  physical  annexation  of 
a  chattel  alone  is  not  always  necessary  to  its  becoming  part 
of  the  realty,  and  as  physical  annexation  alone  does  not 
necessarily  make  a  chattel  realty,  but  in  either  case  other 
circumstances  may  combine  to  prevent  the  one  or  the  other, 
it  is  believed  that  the  true  rule  is  that  articles  not  otherwise 


BUILDING    AND    OTHER    EQUIPMENT  233 

attached  to  realty  than  by  their  own  weight  are  prima  facie 
personalty,  and  articles  affixed  to  land  in  fact,  although  only 
slightly,  are  prima  facie  realty,  and  that  the  burden  of  proof 
is  on  the  one  contending  that  the  former  is  realty  and  that 
the  latter  is  personalty." 

It  has  been  held  by  courts  of  law  that  a  heavy  statue, 
designed  for  permanent  ornamentation  of  a  building,  is  part 
of  the  building,  and  subject  to  a  mortgage  of  that  building  ;^ 
that  a  machine  which  is  attached  to  its  base  merely  to  give  it 
stability,  is  not  part  of  the  building  f  that  shelving  attached 
to  the  walls  merely  to  give  it  steadiness  is  part  of  the  build- 
ing;' that  a  machine  attached  to  the  floor  to  give  it  steadi- 
ness, when  it  is  attached  otherwise  than  by  cleats,  is  part 
of  the  building;*  that  platform-scales  erected  in  the  street, 
but  with  beams  extending  into  an  adjoining  building,  are 
part  of  the  building;^  on  the  other  hand,  belting,  gas  fix- 
tures, and  radiators  have,  in  some  cases,  been  held  to  be 
realty,  while  in  other  cases  they  have  been  held  to  be 
personalty. 

Distinction  Between  Realty  and  Personalty  Fixtures 

In  view  of  the  many  differences  of  opinion  which  the 
decisions  of  the  courts  suggest  in  the  matter  of  fixtures,  it 
seems  that  the  rule  contained  in  the  foregoing  quotation 
from  the  Cyclopaedia  of  Law  and  Procedure  may  safely  be 
accepted  by  accountants.  Thus,  everything  permanently 
attached  to  the  building  and  impossible  of  removal  without 
cutting  into  walls,  ceilings,  and  floors,  or  without  impairing 
the  fitness  of  the  building  for  the  purpose  to  which  it  was 
destined,  may  be  properly  included  in  the  cost  of  the  build- 
ing, or  kept  in  a  separate  account  with  building  equipment  or 
with  realty  fixtures.     Everything  which  is  attached  to  the 


•Snedeker  v.  Warring,  12  N.  Y.  170. 

^McRea  v.  Troy  Cent.  Nat.  Bank.  66  N.  Y.  489. 

'Stack  V.  T.  Eaton  Co.,  4  Ont.  Rep.  335. 

*Sun  L.  Ass.  Co.  v.  Taylor,  9  Manitoba  89. 

*Blissv.  Whitney,  9  Allen  (Man.)  114;  85  Am.  Decennial  745. 


234      "^^^    THEORY    OF    THE    ASSET    ACCOUNTS 

building  by  its  weight  only,  and  can  be  easily  removed  with- 
out in  any  way  interfering  with  the  efficiency  of  the  build- 
ing, or  defacing  it,  may  be  called  furniture  and  fixtures. 

In  the  former  category  we  would  then  include:  boilers 
and  furnaces  imbedded  in  the  floors  or  walls,  machines 
sunken  in  the  floor  or  attached  to  it  in  such  a  manner  as  to 
be  part  of  it,  elevators  and  the  machinery  on  which  they 
depend  for  power,  ventilating  systems,  water  connections, 
piping,  feeding  wires,  inside  sewerage  and  drainage  sys- 
tems, crane  runners  and  supports,  shafting  and  pulleys  which 
are  so  encased  in  the  walls  and  ceilings  as  to  necessitate  cut- 
ting in  order  to  remove  them,  safes,  closets,  benches,  and 
shelving  built  in  the  walls  or  permanently  attached  to  them, 
etc. 

In  the  second  category  (furniture  and  fixtures)  we 
would  include  chairs,  tables,  desks,  pictures,  and  other  re- 
movable decorative  objects,  files  and  cabinets,  writing,  copy- 
ing and  computing  machines,  safes  not  attached  to  the  walls, 
lamps  and  chandeliers,  movable  stoves  and  radiators,  and 
generally  all  the  appliances,  implements,  etc.,  acquired  to 
facilitate  the  transaction  of  business,  or  add  to  the  comfort 
of  the  officials,  employees,  and  patrons  of  the  concern. 

It  is  to  be  understood,  of  course,  that  the  segregation  of 
the  building  into  its  components,  such,  for  instance,  as 
general  building  equipment,  power  plant  equipment,  boiler 
plant  equipment,  heating  plant,  etc.,  is  not  condemned,  pro- 
vided the  sundry  units  are  understood  to  be  part  of  the 
whole,  detached  for  purposes  of  recording  analytically  the 
original  cost  of  the  units  and  the  subsequent  transactions 
affecting  them. 

Furniture  and  Fixtures 

The  Furniture  and  Fixtures  account  has  no  well-defined 
theory :  what  it  will  contain  depends  upon  the  policy  of  the 
concern  as  to  what  it  will  capitalize  and  what  it  will  charge 


BUILDING    AND    OTHER    EQUIPMENT  235 

to  operations.  Some  firms  carry  their  furniture  and  fixtures 
at  their  original  cost,  and  charge  all  subsequent  additions,  re- 
newals, and  repairs  to  the  income  of  the  period  in  which  the 
transactions  occurred ;  others  add  to  the  original  amount  the 
cost  of  what  they  buy,  and  credit  the  account,  periodically, 
with  an  amount  representing  the  difference  between  the  book 
value  and  the  total  inventory  computed  conservatively; 
others  still,  add  the  cost  of  additions  to  the  original  value, 
and  set  aside  yearly  out  of  profits  an  amount  which  is 
credited  to  a  reserve  account  and  is  supposed  to  reflect  the 
amount  of  depreciation  suffered  by  the  property  during  the 
period. 

Delivery  Equipment 

The  somewhat  antiquated  title  of  Horse,  Wagon,  and 
Harness,  which  was  formerly  applied  to  this  account,  is  fre- 
quently replaced,  in  these  modern  days  of  motor  trucks  and 
light-power  delivery  wagons,  by  the  name  "Delivery  Equip- 
ment." What  the  account  will  contain  depends  upon  the 
policy  of  the  concern.  It  is  supposed  to  include  the  cost  of 
such  equipment  as  is  necessary  to  cart  the  goods  in  and  out 
of  the  plant.  Like  the  asset  "furniture  and  fixtures,"  it 
may  be  carried  at  its  original  cost,  all  replacements  and 
additions  being  charged  to  expense;  or  the  original  value 
may  be  added  to  whenever  transactions  take  place,  the  true 
value  being  obtained  through  periodical  inventories  figured 
conservatively.  Or  again,  it  may  be  carried  at  cost,  a  cer- 
tain amount  being  periodically  set  aside  out  of  net  profits 
to  provide  for  such  depreciation  as  it  is  estimated  that  the 
property  may  have  suffered. 

H  losses  occur  either  through  natural  causes  or  through 
accidents,  the  account  is  credited  with  the  original,  or  with 
the  depreciated,  cost  of  the  unit  lost  (as  the  case  may  be) 
and  is  then  debited  with  the  cost  of  the  unit  which 
replaces  it. 


236 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


Patterns 

A  pattern  is  "a  piece  of  paper,  card-board,  sheet  metal, 
or  thin  plank  corresponding  in  outline  to  an  object  that  is  to 
be  cut  out  or  fabricated,  and  serving  as  a  guide  in  determin- 
ing its  exact  shape  and  dimensions.  Pattern  pieces  or 
gauges  are  largely  used  in  making  special  machinery,  in 
which  all  the  parts  are  made  separately  by  gauges,  and  then 
put  together."* 

The  value  at  which  patterns  should  be  carried  on  the 
books  is,  of  course,  their  cost;  that  is  to  say,  the  amount 
of  all  the  expenses  which  their  fabrication  has  necessitated. 
But,  as  the  value  of  the  pattern  is  problematic  after  the 
object  for  which  it  was  made  is  accomplished,  the  ques- 
tion of  the  ultimate  disposition  of  the  asset  is  important. 

The  patterns  made  for  a  special  machine,  which  will 
not  be  used  elsewhere  than  in  the  plant  of  the  concern 
which  built  it,  have  no  value  unless  there  is  a  probability 
that  the  apparatus  will  be  duplicated  at  some  future  time. 
Hence,  if  the  machine  is  to  be  the  only  one  of  its  type,  the 
cost  of  the  patterns  is  an  integral  part  of  the  cost  of  the 
machine.  In  the  contrary  case  it  may  be  retained  as  an 
asset,  at  cost.  If,  peradventure,  the  object  for  which  a 
pattern  is  made  becomes  useless  through  obsolescence  of 
the  type,  the  pattern  itself  necessarily  loses  its  value. 

Patterns  made  to  standardize  the  object  manufac- 
tured, and  used  constantly  as  models,  may  be  retained  as 
an  asset  at  whatever  cost  they  represent.  If  their  useful- 
ness has  expired,  they  should  be  written  off  gradually  by 
periodical  charges  to  the  Profit  and  Loss  account;  or  a 
reserve  may  be  created  for  them  pending  final  decision  as 
to  their  ultimate  disposition.  Under  no  conditions,  how- 
ever, should  they  be  charged  to  cost  of  manufacture  unless 
they  were  made  for  a  special  job  and  there  is  no  possibility 
of  their  being  used  again. 

•  Encyclopsedic  Dictionary. 


BUILDING    AND    OTHER    EQUIPMENT  237 

Other  General  Equipment 

The  theory  of  other  property  accounts  which,  for  the 
sake  of  financial  statements,  may  be  grouped  under  this 
title,  such,  for  instance,  as  Fire  Apparatus,  Emergency 
Equipment,  etc.,  is  substantially  the  same  as  the  theory 
of  the  account  "Delivery  Equipment." 


CHAPTER  XXI 

MACHINERY   AND    TOOLS 

Classification  of  Machinery  and  Tools 

Although  comparatively  few  concerns  attempt  to  make 
their  accounting  differentiate  the  components  of  this  ac- 
count, it  may  be  better  to  subdivide  the  subject  matter  into  its 
units  which,  for  ordinary  manufacturing  businesses,  may  be 
substantially  as  follows : 

1.  Machines;  that  is  to  say,  such  machines  as  are  at- 

tached to  the  floor  or  to  benches  or  to  their  bases 
by  their  weight  only,  or  in  such  a  manner  as  not  to 
make  them  part  of  the  building. 

2.  Machine  Tools. 

3.  Shop  and  Hand  Tools. 

As  opposed  to  the  machine  tool,  the  machine  proper  is 
that  part  of  the  whole  apparatus  which,  by  itself  or  through 
auxiliary  devices,  produces  the  required  motion;  the  ma- 
chine tool,  on  the  other  hand,  is  the  part  of  the  machinery 
which  performs  the  final  function  for  which  the  apparatus 
as  a  whole  was  constructed.  As  to  the  hand  and  shop  tool, 
it  has  nothing  whatever  to  do  with  either.  Taking  as  an 
example  a  milling  machine,  we  find  it  defined  in  the  "En- 
cyclopaedic Dictionary"  as :  "a  machine  for  dressing  metal 
work  to  shape,  by  passing  it  on  a  travelling-bed  beneath  a 
rotating  serrated  cylindrical  cutter."  In  a  machine  of  this 
type  the  part  of  the  apparatus  which  produces  the  motion 
necessary  to  carry  the  object  to  be  dressed  in  the  proper 
position  under  the  cutter,  is  the  machine  proper,  whereas  the 
cutter  is  the  machine  tool. 

238 


MACHINERY    AND    TOOLS 


239 


The  distinction  may  not  appear  important  at  first,  but 
becomes  so  when  it  is  considered  that  while  the  cost  of  the 
original  tool  equipment  (which  may  comprise  several  cut- 
ters) is  proportionately  greater  than  that  of  the  machine, 
the  life  of  the  machine  may  extend  over  a  period  of  twenty 
years  or  more,  whereas  the  cutter  may  be  destroyed  the 
first  time  it  is  used,  either  owing  to  a  flaw  in  the  material  of 
which  it  is  made,  or  through  careless  or  faulty  adjusting. 

Machine  and  Tool  Accounting 

If  the  value  of  the  machine  and  of  the  machine  tools  is 
stated  in  one  account,  and  one  of  the  cutters  is  destroyed, 
the  account  must  be  credited  at  once  with  the  loss  sustained ; 
or  the  recording  of  the  loss  may  be  postponed  until  the  tak- 
ing of  the  physical  inventory  at  the  end  of  the  period;  but 
in  either  case,  the  value  of  the  machinery  and  tools  asset 
must  be  reduced  to  the  value  of  its  remainder.  This  necessi- 
tates the  keeping  of  a  special  machinery  ledger  containing 
an  account  with  each  machine. 

If,  on  the  contrary,  two  accounts  were  created,  one  for 
machines  and  another  for  machine  tools,  a  list  of  the  ma- 
chines could  be  made  once  for  all,  stating  the  date  at  which 
they  were  acquired,  their  cost,  their  estimated  life,  their 
residual  value,  their  factory  number,  their  location  on  the 
floor  of  the  plant,  and  the  rate  of  depreciation  which  is  ap- 
plied to  each  unit  for  purposes  of  reserves.  This  list  would 
constitute  a  permanent  inventory,  subject  only  to  additions 
and  deductions  due  to  the  acquisition  of  new  units  or  to  the 
discarding  of  units  whose  life  has  expired. 

As  to  the  machine  tools,  the  fact  that  they  are  carried  in 
a  separate  account  makes  it  possible  to  place  them  in  the 
custody  of  the  storekeeper,  to  control  their  issue  to  the  fac- 
tory, and  to  obtain  a  periodical  book-inventory  probably 
more  valuable  than  a  physical  one,  since  it  can  be  readily 
checked  and  priced, 


240      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

Universal  Machines 

In  regard  to  machines,  they  may,  if  the  occasion  arises, 
be  subdivided  into  two  distinct  accounts,  one  containing  the 
value  of  the  universal  machines,  the  other  the  value  of  the 
special  machines. 

Universal  machines  are  those  v^hich  are  built  according 
to  a  standard,  and  are  used  by  all  industries  where  the  work 
to  be  performed  calls  for  the  application  of  familiar  princi- 
ples of  mechanics.  Special  machines,  in  contradistinction, 
are  those  which  have  to  be  constructed  to  meet  the  require- 
ments of  special  classes  of  industry,  or  of  new  manufacturing 
processes.  Among  the  former  may  be  mentioned  drilling, 
cutting,  milling,  and  grinding  machines ;  a  good  illustration 
of  special  machines  is  afforded  by  the  hydraulic  diamond- 
headed  filter  through  which,  prior  to  the  discovery  of  the 
wire-pulling  process,  the  metal  composition  used  in  the  man- 
ufacture of  carbons  for  electric  bulb-lamps  was  passed. 

Universal  machines  are  generally  purchased  from  con- 
cerns who  deal  in  them  because  they  are  standardized  arti- 
cles ;  they  are  the  best  product  of  industry  at  the  time  they 
are  acquired,  and  are  subject  to  uniform  prices.  The  value 
at  which  they  are  carried  on  the  books  is  their  original  pur- 
chase cost  as  given  by  invoices,  to  which  may  be  added 
freight  and  cartage,  and  the  cost  of  installation  and  adjust- 
ing. The  cost  of  subsequent  changes  and  alterations  which 
increase  the  efficiency  or  extend  the  life  of  the  machines,  may 
be  capitalized.  The  credits  to  the  account  are  for  losses  due 
to  accidents  which  impair  the  usefulness  of  individual  units, 
either  in  part  or  in  full,  and,  at  the  expiration  of  the  life  of 
the  machine,  for  their  depreciated  value  as  contained  in  the 
reserve  for  depreciation,  and  their  residual  scrap  value. 

Special  Machines 

Special  machines  are  built  either  by  machine  shops,  in 
accordance  with  designs  and  specifications  submitted  by  the 


MACHINERY    AND    TOOLS 


241 


concern  for  whose  account  the  construction  is  undertaken, 
or  by  the  concern  itself.  In  the  former  case,  the  value  at 
which  the  machine  is  stated  is  the  contract  price ;  in  the  latter 
case  it  is  the  cost  of  material  and  labor,  plus  the  freight 
and  cartage  on  the  material  and  a  proper  proportion  of  over- 
head expenses.  In  either  case  the  cost  of  the  experiments 
which  were  conducted  before  a  desirable  type  was  obtained, 
and  the  cost  of  the  designs  and  patterns  which  were  made, 
may  be  added  to  the  value  of  the  machine.  The  cost  of  all 
future  improvements  which  make  the  machine  more  suitable 
to  the  requirements  of  the  concern  and  increase  its  efficiency, 
may  be  added  to  the  original  cost.  As  to  the  question  of 
increase  of  machine  life,  it  is  generally  more  than  counter- 
balanced by  the  danger  of  obsolescence  which  is  ever-present 
in  this  class  of  property.  If  a  competitor  develops  a  type 
which  reduces  the  cost  of  manufacture,  either  by  bringing 
about  time-economy,  or  by  making  possible  substantial 
changes  in  the  process  itself,  the  machine  which  is  not 
capable  of  obtaining  the  same  result  must  be  discarded,  irre- 
spective of  its  cost,  and  a  more  advantageous  one  built. 

Thus,  we  have  in  "special  machines"  an  asset  quite  dif- 
ferent from  the  asset  "universal  machines."  One  is  subject 
to  obsolescence,  and  the  other  is  not;  the  cost  of  one  is  cer- 
tain and  its  components  are  well  known ;  the  cost  of  the  other 
is  uncertain,  and  the  proof  of  the  accuracy  of  its  stated  value 
is  not  readily  obtained.  Barring  accidents,  one  will  be  in 
service  for  a  known  number  of  years ;  under  the  same  condi- 
tions, the  extent  of  the  other's  useful  life  is  problematic. 

Depreciation 

Without  attempting  to  go  deeply  at  this  point  into  the 
subject  of  depreciation,  which  will  be  considered  in  subse- 
quent chapters,  it  is  evident  that  the  irreparable  wear  and 
tear  sustained  by  universal  machines,  either  as  a  result  of 
manufacturing,  or  through  the  mere  efflux  of  the  term  of 


242      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

their  useful  life,  is  quite  different  from  the  possibility  of 
loss  through  obsolescence  which  is  found  in  special  machines. 
If,  then,  the  asset  which  is  to  be  depreciated  is  composed  of 
the  two  distinct  types,  the  reserve  for  depreciation  will  also 
contain  two  kinds  of  losses,  i.e.,  one  which  is  probable  and 
one  which  is  problematic.  It  seems,  under  the  conditions, 
that  the  purpose  of  accounting  would  be  better  served  if  the 
two  types  of  machines  were  kept  separate. 

Shop  and  Hand  Tools 

The  nature  of  the  asset  "shop  and  hand  tools"  is  so 
different  from  that  of  the  two  elements  of  machinery  and 
tools  already  mentioned,  that  it  should  under  all  conditions 
be  stated  by  itself.  The  tools  contained  in  this  account  are 
sometimes  referred  to  as  "small  equipment."  They  com- 
prise saws,  files,  hammers,  screw-drivers,  etc.,  which  on  ac- 
count of  their  fragility,  their  size,  the  manifold  uses  to  which 
they  are  placed,  and  the  facility  with  which  they  can  be 
passed  from  hand  to  hand  and  from  bench  to  bench,  cannot 
be  readily  or  accurately  inventoried.  They  are  generally 
kept  under  the  custody  of  a  storekeeper,  and  charged  to  cost 
of  manufacture  when  issued  to  the  factory.  In  some  case';, 
they  are  consigned  to  the  workingmen,  and  submitted  peri- 
odically to  the  inspection  of  the  storekeeper ;  at  this  time,  the 
broken  and  worn-out  tools  are  charged  to  the  cost  of  manu- 
facture, and  the  cost  of  the  tools  lost  is  charged  to  the  wages 
of  the  careless  workmen;  in  either  case,  credit  is  given  to 
the  general  ledger  account  containing  their  value.  Which- 
ever way  they  are  treated,  they  are  not  subject  to  depre- 
ciation. 


CHAPTER  XXII 

GOOD-WILL,   PATENTS,   TRADE-MARKS,   COPY- 
RIGHTS, FRANCHISES 

GOOD-WILL 

Definition 

One  of  the  most  commonly  quoted  definitions  of  good- 
will, so  far  at  least  as  accountants  are  concerned,  is  the  one 
given  by  Lisle  in  his  book  "Accounting  in  Theory  and  Prac- 
tice" :  "Good-will  is  the  monetary  value  placed  upon  the 
connection  and  reputation  of  a  mercantile  or  manufacturing 
concern,  and  discounts  the  value  of  the  turnover  of  a  busi- 
ness in  consequence  of  the  probabilities  of  the  old  customers 
continuing." 

Another  definition  is  the  one  appearing  in  the  opinion  of 
Lord  Elton  in  the  English  case  of  Crutwell  v.  Lye,  which 
is  about  one  hundred  years  old :  "The  good-will  which  has 
been  the  subject  of  a  sale,  is  nothing  more  than  the  prob- 
ability that  the  customers  will  resort  to  the  old  place." 

Lord  Elton's  definition  gives  the  impression  that  good- 
will is  a  purely  local  matter,  and  that  if  a  concern  having 
acquired  the  business  of  another,  subsequently  transfers  it 
to  a  different  locality,  it  loses  the  right  to  expect  that  the 
old  customers  will  continue.  This  is  indeed  the  stand  taken 
by  a  Pennsylvania  court  in  the  case  of  Elliot's  appeal  (60 
Pa.  St.  161)  in  which  It  was  held  that  the  good-will  of  an 
inn,  or  tavern,  did  not  exist  outside  of  the  premises  where 
the  business  was  conducted  at  the  time  of  the  sale. 

Lord  Elton's  definitfon  has,  however,  been  the  subject  of 

243 


244      ^^^    THEORY    OF    THE    ASSET    ACCOUNTS 

much  criticism  in  and  out  of  American  courts,  owing  to  its 
narrow  conception  of  the  valuable  asset  "good-will."  Nor 
does  it  seem  that  English  courts  have  shared  his  views. 
Vice-Chancellor,  Sir  W.  Page  Wood,  says:  "Good-will,  I 
apprehend,  must  mean  every  advantage  *  *  *  that  has  been 
acquired  by  the  old  firm  in  carrying  on  its  business,  whether 
connected  with  the  premises  in  which  the  business  was  previ- 
ously carried  on,  or  with  the  name  of  the  late  firm,  or  with 
any  other  matter  carrying  with  it  the  benefit  of  the  business." 

Personal  Character  of  Good- Will 

Purely  local  as  the  character  of  good-will  is  under  cer- 
tain conditions  (as  for  instance  in  the  case  of  a  hotel  whose 
attractive  and  convenient  location  is  primarily  responsible 
for  the  vogue  which  it  enjoys)  it  may  be  said  to  be  more 
commonly  personal.  If  Steinway  and  Sons  were  to  sell  their 
business  and  their  name  to  a  firm  who  found  it  advisable  to 
transfer  the  plant  and  the  selling  agency  from  New  York 
to  Boston,  it  is  certain  that  the  good-will  of  the  musical 
world  would  not  be  affected  by  the  change. 

It  is  precisely  that  element  of  personality  possessed  by 
good-will  which  links  it  so  naturally  to  types  of  organiza- 
tion in  which  the  names  of  the  supposed  proprietors  are 
known,  that  is  to  say,  sole  proprietorships  and  copartner- 
ships. It  is  also  on  this  account  that  the  courts  have  ruled 
that  the  good-will  of  a  partnership  does  not  inure  to  the 
benefit  of  the  surviving  partners,  but  belongs  to  the  pur- 
chaser of  the  firm  name,*  and  that  the  good-will  of  a  market 
stand  or  stall  the  lessee  of  which  has  died,  is  independent  of 
the  stand  itself  and  belongs  to  the  estate  of  the  deceased.! 

Good-will  is  very  frequently  referred  to  as  an  "intangible 
asset,"  that  is  to  say,  something  the  existence  of  which  is 
spoken  of,  but  is  not  palpable.     Intangible  as  it  may  be  by 


•  Slater  y.  Slater.  175  N.  Y.  143  (1903). 
T  Joume  s  buccession,  21  La.  Ann.  391. 


V 


GOOD-WILL 


245 


itself,  it  must  nevertheless  rest  upon  something  tangible;  it 
is  not  conceivable,  for  instance,  that  a  skilled  surgeon  whose 
fame  is  far-reaching  could  sell  the  good-will  of  his  practice 
to  an  unknown  confrere  whose  skill  has  yet  to  be  demon- 
strated. There  is  nothing  tangible  in  the  assurance  of  the 
vendor  surgeon  that  his  patients  will  be  willing  to  intrust 
their  lives  to  his  successor.  Good-will  in  this  case  is  non- 
existent as  a  marketable  value,  since  it  depends  upon  per- 
sonal skill  which  is  not  to  be  acquired  through  purchase.  On 
the  other  hand,  a  physician  practising  without  competition 
in  a  rural  district  could  in  all  propriety  place  a  value  on  the 
good-will  of  his  practice,  provided  he  were  to  agree  to 
recommend  the  purchaser  to  his  patients  as  fully  capable  of 
giving  them  equally  skilled  service,  and  agree  to  retire,  or 
to  move  to  another  state  or  to  another  part  of  the  same 
state.  Good-will  in  this  case  would  rest  upon  the  monopo- 
listic prerogative  of  the  vendee.  This  is  so  true  that  if  the 
vendor  subsequently  performed  an  act  which  would  tend  to 
defeat  the  certainty  of  monopoly  now  possessed  by  the 
vendee,  such,  for  instance,  as  announcing  the  resumption  of 
his  practice  in  the  field  of  his  former  activities,  the  courts 
would  invalidate  the  contract  and  relieve  the  aggrieved 
vendee  of  his  obligations  under  the  contract  of  sale.* 

The  Good-Will  of  Corporations 

The  nature  of  the  good-will  of  corporations  may  be  quite 
different  from  that  of  the  good-will  of  sole  proprietorships 
and  of  copartnerships.  When  corporations  sell  their  assets 
it  often  happens  that  the  identity  of  the  vendor  is  lost  in 
that  of  the  vendee.  In  this  case  the  purchaser  does  not 
acquire  the  right  to  expect  that  the  customers  of  the  vendor 
will  resort  to  the  old  place.  He  acquires  the  earning  power 
of  an  established  business  whose  products  will  sell,  no  matter 
who  offers  them  for  sale ;  he  figures  that,  with  more  up-to- 


*  Townsend  v.  Hurst,  37  Missouri  679, 


246      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

date  methods  of  conducting  the  business,  and  through  the 
application  of  scientific  economy,  and  the  union  of  forces 
hitherto  antagonistic,  larger  profits  will  be  obtained  than 
were  possible  before  the  consolidation  of  interests  took  place. 
For  this,  he  is  willing  to  pay  a  sum  of  money  which  may  be 
far  in  excess  of  the  properties  acquired. 

In  the  absence  of  a  better  term,  accountants,  as  well  as 
laymen,  are  generally  satisfied  to  call  this  excess  price  good- 
will; but  the  frequency  with  which  the  excess  of  cost  over 
the  intrinsic  value  of  the  properties  acquired  is  distributed 
by  boards  of  directors  over  the  value  of  the  individual  prop- 
erty units  included  in  the  purchase,  no  mention  whatever 
being  made  of  good-will,  indicates  that  there  is  some  deep- 
rooted  objection  to  the  term,  at  least  from  the  point  of  view 
of  corporations. 

There  are,  in  fact,  any  number  of  instances  of  consolida- 
tions of  corporations  where  the  application  of  the  word 
good-will  to  the  excess  price  paid  by  the  consolidating  in- 
terests over  the  intrinsic  value  of  the  properties  acquired, 
would  be  equivalent  to  an  attempt  to  mislead,  or  to  an  ad- 
mission of  ignorance  of  the  conditions  which  brought  about 
the  combination.  The  earning  power  of,  say,  three  corpora- 
tions to  be  consolidated  may  have  been  reduced  to  a  negli- 
gible quantity  by  the  keenness  of  the  competition  in  which 
they  have  engaged.  If  that  earning  power  were  to  be  used 
as  the  basis  for  the  computation  of  the  value  of  good-will  in 
accordance  with  the  rules  which  are  said  to  prevail  in  such 
cases,  there  would  remain  a  minus  quantity  to  express  the 
good-will  valuation.  And,  yet,  the  stockholders  of  the  three 
competing  companies  may  not  feel  disposed  to  combine  un- 
less they  receive  a  considerable  amount  over  the  intrinsic 
value  of  the  properties  which  they  control.  Thus,  so  far  as 
earning  power  is  concerned,  the  bonus  paid  does  not  apply 
to  past  performances  but  to  confidence  in  the  future.  If  the 
word  good-will  applies  to  anything,  under  these  conditions. 


GOOD-WILL  247 

it  must  be  to  that  harmony  which  the  consolidation  has 
brought  about  among  forces  which  up  to  now  were  only 
desirous  of  destroying  one  another. 

Good- Will  as  an  Asset 

It  should  be  said,  however,  that  while  any  reference  to 
good-will  may  properly  be  eliminated  from  the  books  of  a 
corporation  which  absorbs  other  interests  in  such  a  manner 
as  to  cause  the  identity  of  the  vendor  to  be  entirely  lost,  it 
should  be  retained  as  an  asset  of  a  corporation  which  takes 
over  a  copartnership  or  a  sole  proprietorship,  particularly 
when  the  vendee  concern  retains  enough  of  the  name  of  the 
vendor  to  preserve  the  personal  character  of  the  good-will 
purchased. 

The  importance  of  the  asset  "good-will"  when  it  has 
been  acquired  by  purchase,  cannot  be  overestimated.  There 
is  no  other  asset  of  a  concern  the  sale  of  which  would  be  so 
effective  in  bringing  operations  to  an  end.  In  some  instances 
it  has  been  held  by  courts  of  law  that  under  the  terms  of  a 
contract  for  the  sale  of  good-will,  the  vendor  has  no  subse- 
quent right  to  solicit  trade  in  the  section  of  the  country  in 
which  he  previously  operated,  even  among  people  who  were 
not  his  customers  at  the  time  of  the  sale.*  The  sale  of  good- 
will may  even  prevent  an  individual  from  using  his  own 
name  in  connection  with  the  line  of  business  in  which  he  has 
engaged  prior  to  the  sale.  Judge  Batesf  quotes  a  case  in 
which  Beatty  and  Gage  formed  a  partnership  whose  most 
valuable  asset  was  a  series  of  copy  books,  known  as  "Beatty's 
Head  Line  Copy  Books."  They  dissolved.  Gage  buying  out 
Beatty's  interest  for  $20,000.  It  was  shown  that  a  large 
part  of  the  price  was  for  the  right  to  sell  the  copy  books. 
A  publishing  company,  with  Beatty's  assistance,  got  out  a 
new  series  called  "Beatty's  New  and  Improved  Head  Line 


*  Munsey  v.  Butterfield,  133  Mass.  492. 
t  "Law  of  Partnershipt  " 


248 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


Copy  Books."  This  was  held  to  be  an  infringement  of 
Gage's  rights,  the  word  Beatty  as  applied  to  the  books 
being  a  valuable  asset  which  passed  to  Gage.* 

Depreciation  of  Good- Will 

Why  good-will,  having  been  acquired  at  a  cost  which  is 
sometimes  considerable,  and  constituting  in  some  instances 
the  only  truly  valuable  asset  of  a  concern,  should  be  out- 
lawed and  sentenced  to  gradual  expulsion  from  respectable 
books,  is  one  of  the  perplexing  puzzles  which  accounting 
offers  to  its  students.  Accountants  who  would  never  permit 
the  reduction  of  a  physical  asset  by  the  estimated  amount  of 
depreciation  which  it  may  or  may  not  have  suffered  during 
a  given  period,  have  no  scruples  at  all  when  it  comes  to  good- 
will. Still,  it  seems  that  if  a  concern  has  paid  a  large  sum 
to  acquire  the  good-will  of  another,  and  has  not  only  re- 
tained it  but  even  increased  it,  there  is  no  apparent  reason 
why  so-called  conservatism  should  demand  the  writing  off 
of  the  asset  to  the  detriment  of  the  very  profits  which  its 
purchase  gave  the  right  to  expect. 

One  of  the  reasons  frequently  advanced  in  favor  of  this 
writing  off  policy,  is  that  the  valuation  of  good-will,  being 
based  on  a  given  number  of  years'  purchase  of  the  average 
net  profits  of  the  vendor  concern,  less  a  fair  return  on  capi- 
talization, its  cost  is  consumed  concurrently  with  the  efflux 
of  the  period  for  which  it  has  been  purchased.  This  is,  in- 
deed, an  extreme  view.  It  is  unequivocally  expressed  in 
Clarence  Munro  Day's  "Accounting  Practice" :  "Good-will 
is  a  legitimate  asset  in  an  industrial  enterprise  and  the  most 
accepted  method  of  computing  the  amount  of  good-will  is 
to  take  the  total  profits  for  the  last  five  years  and  deduct 
from  them  five  years'  interest  on  the  capitalization  at  seven 
per  cent  per  annum ;  the  balance  is  good-will.  The  rate  of 
interest  is  based  on  the  assumption  that  no  capitalist  would 

•  Gage  V.  Canada  Publishing  Co.,  n  Ont.  App.  402. 


GOOD-WILL  249 

invest  in  an  enterprise  unless  he  was  assured  at  least  seven 
per  cent  annual  return.  Good-will  should  be  written  oflf  the 
books  during-  five  subsequent  years  by  charging  off  one-fifth 
against  each  succeeding  year." 

As  opposed  to  this  view,  which  we  have  qualified  as 
extreme,  the  following  quotation  from  Dicksee's  "Auditing" 
may  be  of  interest:  "Good-will  does  not  depreciate.  On 
the  other  hand,  it  will  generally  be  conceded  that  it  is  liable 
to  fluctuations,  both  continual  and  extreme  *  *  *  As  a 
matter  of  fact,  good-will  is  not  written  down  because  its 
value  is  supposed  to  have  become  reduced — such  a  course 
is  all  but  unknown.  The  amount  at  which  good-will  is 
stated  in  a  balance  sheet  is  never  supposed  to  represent 
either  its  maximum  or  its  minimum  value;  no  one  who 
thought  of  purchasing  a  business  would  be  in  the  least 
influenced  by  the  amount  at  which  the  good-will  was  stated 
in  the  accounts ;  in  short,  the  amount  is  absolutely  meaning- 
less, except  as  an  indication  of  what  the  good-will  may  have 
cost  in  the  first  instance.  Inasmuch,  therefore,  as  nobody 
can  be  deceived  by  its  retention,  there  is  no  necessity  for  the 
amount  of  good-will  account  to  be  written  down.  On  the 
other  hand,  the  practice  is  not  unusual,  where  sufficient 
profits  are  being  made.  The  question  is  not,  however,  one 
upon  which  the  auditor  is  required  to  express  an  opinion." 

Creation  of  Good- Will 

It  is  generally  recognized  that  the  question  of  the  value 
of  good-will  does  not  arise  until  a  sale  is  contemplated. 
Thus,  it  does  not  seem  possible  for  a  concern  which  has  or- 
ganized otherwise  than  by  purchase  of  an  already  established 
business,  to  create  the  asset  "good-will"  during  the  course  of 
its  operations  as  a  going  concern.  Still,  if  it  is  considered 
proper  to  set  aside  the  expenses  of  organization  in  an  ac- 
count which  will  be  reduced  periodically  during  the  years  to 
which  the  benefit  derived  therefrom  applies;  if  further,  it 


250      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

is  agreed  that  corporations  have  the  right  to  spread  the  loss 
incurred  through  discounts  on  bonds  over  the  hfe  of  the 
bonds,  there  does  not  seem  to  be  a  valid  objection  to  the 
charging  of  the  operating  shortcomings  of  what  might  be 
called  the  "probation  period"  of  a  newly  established  business 
to  an  account  which  would  record  the  cost  of  obtaining  the 
good-will  of  the  community. 

We  often  hear  of  concerns  which  expect  to  lose  money 
during  the  first  five  years  of  operation,  owing  to  the  heavy 
advertising  which  they  will  have  to  do  in  order  to  call  the 
public's  attention  to  the  value  of  their  goods.  If  the  cost  of 
such  advertising  is  charged  to  expense,  together  with  other 
lavish  expenditures  which  a  newly  established  business  is 
bound  to  make  at  the  start  to  win  the  favor  of  those  whom 
curiosity  first  attracts  to  the  establishment,  a  considerable 
deficit  may  be  shown.  Would  it  not  be  better  to  raise  an 
account  with  good-will,  which  would  be  made  to  reflect  the 
extraordinary  cost  of  establishing  the  business,  and  to  dis- 
tribute that  cost  over  the  future  periods  which  are  to  be 
benefited  thereby? 

PATENTS 

Nature  of  Patents 

Black's  Law  Dictionary  defines  a  patent :  "A  grant  made 
by  the  Government  to  an  inventor  conveying  and  securing 
to  him  the  exclusive  right  to  make  and  sell  his  invention  for 
a  term  of  years."  Thus,  a  patent  is  nothing  short  of  a 
monopoly  granted  by  the  State,  presumably  as  an  induce- 
ment to  the  inventor  to  disclose  the  secret  of  his  invention 
for  the  benefit  of  the  public  at  large.  The  territory  over 
which  the  monopoly  extends  is  mentioned  in  both  the  letters 
patent  issued  to  the  inventor  and  in  the  statute  authorizing 
the  issue  of  patents.  United  States  patents  apply  to  all  the 
states  and  organized  territories,  as  well  as  to  American  ves- 


PATENTS  251 

sels  on  the  high  seas.  They  do  not,  however,  apply  to 
foreign  vessels  in  American  ports.  In  certain  foreign  coun- 
tries— England,  for  instance — a  patent  which  has  not  been 
operated  for  four  years  may  be  revoked,  but  in  the  United 
States  the  right  of  the  patentee  is  not  thus  affected.  In 
England,  the  Crown  reserves  the  right  to  use  the  patented 
invention  in  return  for  fair  compensation ;  while  the  United 
States  Government  does  not  reserve  that  right  to  itself. 
However,  no  injunction  can  be  obtained  against  the  Govern- 
ment, and  it  is  within  its  power  to  use  the  invention  by  pay- 
ing therefor  reasonable  fees  to  the  inventor. 

In  the  United  States  the  term  of  a  mechanical  patent  is 
seventeen  years  from  the  date  of  grant ;  the  term  of  a  design 
patent  is  three  years  and  one-half,  or  seven  years,  or  four- 
teen years,  according  to  the  application.  In  England  the 
patent  expires  with  any  foreign  patent  granted  before  the 
English  patent ;  in  Canada  it  expires  with  any  foreign  patent 
granted  during  its  life.  In  the  United  States  a  patent  can 
be  extended  by  special  act  of  Congress. 

Treatment  of  Patents 

The  value  at  which  the  asset  "patents'*  is  carried  on  the 
books,  depends  upon  whether  the  concern  which  owns  it  is 
the  inventor,  or  has  acquired  it  from  the  inventor.  In  the 
former  case,  its  value  is  the  cost  of  conducting  the  experi- 
ments which  have  led  to  the  invention,  and  the  fees  paid  in 
connection  with  the  search  as  to  the  validity  of  the  claim  for 
the  patent,  and  with  the  filing  of  the  claim.  In  the  latter 
case  its  value  will,  of  necessity,  be  what  the  concern  paid 
for  it. 

Since  patents  grant  what  may  be  termed  a  legal  monop- 
oly, it  is  clear  that  they  convey  a  sort  of  a  title  to  the  good- 
will of  the  community  in  which  the  right  to  exclude  every- 
body except  the  Government  from  the  use  of  the  invention 
is  exercised.    This  is  why  so  many  corporations  which  ac- 


2C2      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

quire  the  business  of  other  concerns  where  a  patent  is  in- 
cluded among  the  assets,  carry  the  excess  price  paid  over  the 
intrinsic  value  of  the  property  acquired,  under  the  term 
"Patents  and  Good-Will,"  or  merely  spread  it  over  the  value 
of  the  patents. 

If  the  monopoly  granted  by  the  patents  lasts  only  for  a 
term  of  years,  it  would  seem  that  the  asset, should  be  written 
off  during  the  life  of  the  grant.  This  can  be  done  in  two 
ways: 

1.  Credit  Patents  and  debit  Profit  and  Loss  with  equal 

instalments  corresponding  in  number  to  the  number 
of  years  during  which  the  patent  continues  to  be 
operative. 

2.  Credit    Patents,    or   Reserve    for   Amortization    of 

Patents,  and  debit  one  of  the  components  of  the 
cost  of  goods  sold,  with  periodical  amounts  repre- 
senting the  probable  royalty  which  would  have  to 
be  paid  on  the  sales  if  the  patents  were  operated  on 
a  royalty  instead  of  owned.  If  the  reserve  account 
has  been  created,  debit  it  and  credit  Patents  as  soon 
as  the  two  accounts  are  equal  in  amount. 

It  will  be  noticed  that  the  second  method  makes  the  cost 
of  manufacture  bear  the  loss  sustained  through  the  natural 
extinction  of  the  very  asset  which  made  operations  possible 
and  created  a  legal  monopoly;  further,  that  it  leads  to  the 
peculiar  conclusion  that  the  income  from  sales  becomes 
larger  as  soon  as  the  asset  "Patents"  has  been  eliminated. 
When  speaking  of  the  statement  of  income  we  shall  have 
occasion  to  refer  again  to  the  oddity  of  accounting  conclu- 
sions to  which  we  are  led  by  certain  accounting  theories  and 
methods. 

It  should  be  stated  that,  instead  of  bein^f  written  oflT, 
patents  have  frequently  been  appraised  on  the  basis  of  the 
saving  in  royalties  which  their  possession  affords,  precisely 


TRADE-MARKS  353 

like  water-power  rights  have  been  appraised  on  the  basis  of 
the  saving  in  fuel  and  power-producing  machinery  effected 
by  the  use  of  natural  forces. 

There  exists  another  theory  to  the  effect  that  while  it  is 
true  that  patents  expire  within  a  certain  number  of  years, 
the  benefit  derived  from  them  by  the  business  does  not  ex- 
pire concurrently.  It  is  pointed  out  that  the  species  of 
monopoly  granted  by  patents  is  bound  to  create  a  consider- 
able amount  of  good-will,  the  existence  of  which  is  appre- 
ciated by  would-be  competitors,  and  deters  them  from 
engaging  in  a  line  of  business  which  has  been  for  so  many 
years  the  exclusive  domain  of  an  established  concern.  Un- 
der this  theory,  it  would  be  possible  to  retain  the  asset  value 
of  a  patent  long  after  its  legal  termination,  by  transferring 
this  value  to  the  Good-will  account. 

TRADE-MARKS 

Definition 

A  trade-mark  is  nothing  more  than  a  conventional  sign 
which,  for  commercial  purposes,  has  the  same  effect  as  the 
signature  has  upon  a  written  document;  they  both  certify 
to  the  origin  or  authorship  of  the  thing  to  which  they  are 
appended. 

Trade-marks  make  it  possible  for  their  owners  so  to 
earmark  their  goods  as  to  make  them  easily  recognizable  by 
buyers ;  in  other  words,  they  guarantee  that  whatever  good- 
will attaches  to  the  product,  will  be  certain  to  revert  to  the 
proper  party.  In  the  case  of  Liedersdorf  v.  Flint,*  it  was 
said: 

"The  court  proceeds  upon  the  ground,  that  the  com- 
plainant has  a  valuable  interest  in  the  good-will  of  his  trade 
or  business,  and  that  having  appropriated  to  himself  a  par- 


*  IS  Fed.  Cmcc  319  (Note  S). 


2CA      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

ticular  label,  or  sign,  or  trade-mark,  indicating  that  the 
article  is  manufactured  or  sold  by  him  or  by  his  authority, 
or  that  he  carries  on  his  business  at  a  particular  place,  he  is 
entitled  to  protection  against  any  other  person  who  pirates 
upon  the  good-will  of  his  customers  or  of  the  patrons  of  his 
trade  or  business,  by  sailing  under^  his  flag  without  his 
authority  or  consent." 

Since  an  unauthorized  use  of  trade-marks  constitutes  an 
infringement  of  the  owner's  right  to  exclusiveness,  it  may  be 
said  of  them  that  they  confer  a  monopoly  different  from  the 
one  obtained  under  patents,  in  that  its  duration  is  not  limited 
by  statute,  and  can  be  exercised  as  long  as  one  desires  to  use 
the  marks  for  trade  purposes.  Thus,  the  main  distinction 
between  patents  and  trade-marks  is  that  the  former  need  not 
be  used  to  remain  in  force,  whereas  the  latter  must  be  used 
or  the  owner's  exclusive  right  to  them  is  lost. 

While  the  cost  of  trade-marks  may  be  insignificant  when 
acquired  otherwise  than  by  purchase  from  former  owners, 
their  value  may  be  considerable,  because  the  very  success  of 
the  goods  which  they  protect  means  the  acquisition  of  the 
good-will  of  the  trade  to  which  these  goods  are  offered  for 
sale.  If  trade-marks  have  been  acquired  from  another  con- 
cern their  cost  may  be  high,  owing  to  the  good-will  which 
they  convey.  No  matter  what  their  cost  may  be,  their  in- 
fluence upon  the  prosperity  of  the  business  is  so  well  defined 
that  they  are  entitled  to  a  place  among  the  invested  values 
of  the  enterprise.  If  kept  in  force,  their  value  should  not 
be  written  off.  If  abandoned,  they  may  be  closed  by  debit 
to  profit  and  loss,  precisely  like  all  other  assets  which  have 
outlived  their  usefulness ;  or  they  may  be  written  off  gradu- 
ally during  a  period  of  years,  upon  the  theory  that  although 
given  up,  they  have  brought  good-will  to  the  business  of 
future  years;  or  again,  their  original  cost  may  be  transferred 
to  the  good-will  to  be  written  down  with  that  asset,  if  such 
is  the  policy  of  the  concern. 


COPYRIGHTS  255 

COPYRIGHTS 
Definition 

Bouvier's  Law  Dictionary  defines  copyrights  as  "the  ex- 
clusive privilege,  secured  according  to  certain  legal  forms, 
of  printing,  or  otherwise  multiplying,  publishing,  and  vend- 
ing, copies  of  certain  literary  or  artistic  productions." 

In  the  United  States,  to  be  entitled  to  a  copyright  one 
must  make  application  therefor,  remitting  at  the  same  time 
the  required  fee,  and  cause  to  be  delivered  to  the  Library  of 
Congress  two  copies  of  the  work. 

Like  trade-marks  and  patents,  copyrights  give  a  monop- 
oly; but  in  their  case  the  privileges  is  limited  to  a  term  of 
twenty-eight  years  from  the  time  of  recording.  The  term 
can  be  extended  for  twenty-eight  years,  upon  request  by  the 
author,  his  widow,  or  his  children,  within  one  year  after  the 
termination  of  the  original  grant.  This  privilege  does  not 
extend  to  the  assignee,  unless  so  provided  in  the  contract  of 
assignment. 

Copyrights  are  personal  property ;  as  such,  they  may  be 
willed;  in  the  absence  of  a  will,  they  descend  to  the  natural 
heirs. 

The  nature  of  the  species  of  monopoly  granted  by  copy- 
rights, consists  in  the  privilege  enjoyed  by  the  owner  or  his 
assignee  or  full  licensees,  to  prevent  any  unauthorized  sale 
of  the  copyrighted  works,  and  the  publication  of  mutilated 
parts  thereof. 

Cop5rrights  as  an  Asset 

The  question  of  the  value  of  the  asset  "copyrights"  is 
a  complicated  one.  The  original  cost  of  obtaining  the  grant 
is  insignificant  unless  the  value  of  the  time  consumed  in  the 
preparation  of  the  work  be  capitalized,  together  with  the 
expenses  incident  thereto  and  with  the  cost  of  such  prelim- 
inary advertising  as  may  have  been  deemed  necessary. 


256 


THE  THEORY  OF  THE  ASSET  ACCOUNTS 


In  the  case  of  copyrights  which  are  valuable  only  to  the 
original  grantee,  such,  for  instance,  as  catalogues,  price 
lists,  and  advertisements,  the  cost  of  plates,  etchings,  half- 
tones, etc.,  may  be  added  to  the  value  of  the  asset  as  stated 
above.  But  in  the.  case  of  assignable  copyrights,  the  plates, 
etchings,  and  half-tones  are  so  independent  of  the  right  it- 
self that  they  can  be  sold  without  giving  the  purchaser  the 
slightest  claim  upon  the  copyright  unless  so  provided  in  the 
contract. 

The  probable  value  of  assignable  or  salable  copyrights 
depends,  to  a  great  extent,  upon  an  estimate  of  the  vogue 
which  they  will  enjoy;  their  real  value  depends  upon  past 
performances  so  far  as  public  favor  is  concerned,  as  well  as 
upon  an  estimate  of  the  continuation  of  their  vogue. 

Copyrights,  being  a  monopolistic  grant,  raise  naturally 
the  question  of  good-will.  A  copyrighted  work  may  have 
been  a  financial  failure  and  yet  have  obtained  an  artistic 
success  such  as  to  lift  its  author  and  its  publishers  to  a  very 
high  plane  in  the  favor  of  a  certain  class  of  readers.  If  the 
defects  which  made  it  commercially  unprofitable  can  be 
remedied  in  future  works  of  the  same  author,  the  good-will 
which  the  first  production  has  acquired  may  enhance  greatly 
the  commercial  success  of  subsequent  copyrights.  Hence, 
the  losses  sustained  by  the  poor  seller  might  be  capitalized 
under  the  name  of  good-will,  or  added  to  the  value  of  the 
copyright,  at  least  until  such  time  as  the  retroactive  eflfect 
of  subsequent  successful  works  upon  the  unsuccessful  one 
has  been  ascertained. 

FRANCHISES 

Definition 

Franchises  have  been  defined  as  "a  branch  of  the  sov- 
ereign power  of  the  State,  subsisting  in  a  person  or  in  a 
corporation,  by  grant  from  the  State."    This  definition  has 


FRANCHISES  257 

been  assailed,  upon  the  ground  that  it  fails  to  establish  a 
proper  distinction  between  "primary  franchises"  and  "sec- 
ondary franchises." 

Primary  Franchises 

Primary  franchises  are  special  privileges,  not  generally 
possessed  by  individuals,  which  are  granted  by  the  State 
pursuant  to  a  well-defined  policy  of  government  or  of  busi- 
ness control.  They  include :  the  right  of  perpetuity  of  pur- 
pose and  of  life,  which  corporations  obtain  by  virtue  of  their 
charter ;  the  privilege  of  limited  liability  which  certain  forms 
of  organization  receive  from  the  State,  as  well  as  all  the 
other  special  privileges  which  their  legal  status  conveys,  and 
the  rights  and  prerogatives  which  all  citizens  enjoy  under 
existing  statutes,  or  in  accordance  with  the  spirit  of  the 
common  law. 

Secondary  Franchises 

Secondary  franchises,  at  least  under  the  American  sys- 
tem of  government,  originate  through  a  contract  made  upon 
valuable  consideration,  between  the  sovereign  power  and  in- 
dividuals or  corporations.  The  consideration  for  the  con- 
tract may  be  monetary,  or  it  may  be  only  the  public  value  of 
the  services  to  be  rendered  by  the  party  seeking  the  grant. 
They  include,  in  the  language  of  the  Supreme  Court :  "rights 
and  privileges  which  are  essential  to  the  operations  of  the 
corporation,  and  without  which  its  road  and  works  should 
be  of  little  value ;  such  as  the  franchise  to  run  cars,  to  take 
tolls,  to  appropriate  earth  and  gravel  for  the  bed  of  its  road, 
or  water  for  its  engines,  and  the  like."* 

The  main  distinction  between  the  two  classes  of  fran- 
chises, so  far  as  organized  business  bodies  are  concerned,  is 
that  the  former  (primary)  cannot  be  alienated,  assigned, 
mortgaged,  or  otherwise  disposed  of,  while  the  latter  (sec- 

*  Morgan  v.  Louisiana,  93  U.  S.  217;  23  L.  Ed.  860. 


2  eg      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

ondary)  may  be,  if  proper  authorization  is  given  by  the 
sovereign  power  which  made  the  grant. 

Generally  speaking,  secondary  franchises  are  monopolis- 
tic and  permanent  rights  "to  do  an  act,  or  a  series  of  acts 
of  public  concern."^  They  constitute  a  contract  between  the 
grantor  and  the  grantee,  which  cannot  be  revoked  unless  the 
grantor  specifically  reserves  to  himself  the  right  of  revo- 
cation. 

The  characteristic  feature  of  franchises  is  that  they  must 
be  granted  by  a  sovereign  power.  Under  this  interpretation 
of  the  nature  of  the  grant,  it  has  been  claimed  that  the 
privileges  conferred  by  the  municipalities  are  not  franchises 
but  merely  hcenses.^  On  the  other  hand,  it  has  been  held 
that  if  the  grantee  of  the  municipal  licenses  has  given  ade- 
quate consideration  (such  as  a  promise  to  pay  to  the  munici- 
pality a  certain  proportion  of  its  earnings  or  of  its  net 
profits),  the  grant  ceases  to  be  a  license  and  becomes  a  fran- 
chise which  is  in  the  nature  of  a  binding  contract  and  cannot 
be  revoked  at  the  will  of  the  grantor.^ 

The  legal  doctrine  which  attempts  to  establish  a  differ- 
ence between  the  franchises  granted  by  a  state  and  those 
granted  by  municipalities,  is  generally  thought  to  be  un- 
sound, upon  the  ground  that  municipalities,  being  state  cor- 
porations and  part  of  the  body  politic,  are  mere  subdivisions 
of  the  sovereign  power.  The  question  as  to  whether  or  not 
the  grant  of  a  franchise  by  a  city  is  an  infringement  of  the 
right  of  the  state,  appears  to  be  one  of  legal  proceedings, 
and  not  a  question  of  fact.* 

Charges  Against  Franchises 

In  connection  with  the  components  of  the  book  value  of 
the  asset  "Franchises,"  when  possessed  by  public  service  cor- 

»  Southampton  v.  Jessup,  162  N.  Y.  122,  126;  56  N.  E.  538. 

"  Chicago  City  R.R.  v.  People,  73  111.  541. 

!  £'^"=^1,?  Municipal  Gas  Light,  etc.,  Co.  v.  Lake,  130  111,  4a;  22  N.  E.  616. 

•  East  Cleveland  R.R.  Co.,  6  Ohio  Cir.  Ct.  318, 


FRANCHISES 


259 


porations,  the  Public  Service  Commission  of  the  first  district 
of  the  State  of  New  York  has  ruled : 

"To  this  account  shall  be  charged  'the  amount  (exclu- 
sive of  any  tax  or  annual  charge)  actually  paid  to  the  state 
or  to  a  political  subdivision  thereof,  as  the  consideration  for 
the  grant  of  such  franchise  or  right'  (Section  55  of  the 
Public  Service  Commission  Law)  as  is  necessary  to  the 
conduct  of  the  corporation.  If  any  such  franchise  is  ac- 
quired by  assignment,  the  charge  to  this  account  in  respect 
thereof  must  not  exceed  the  amount  actually  paid  therefor 
by  the  corporation  to  its  assignor,  nor  shall  it  exceed  the 
amount  specified  in  the  statute  above  quoted.  Any  excess 
of  the  amount  actually  paid  by  the  corporation  over  the 
amount  specified  in  the  statute,  shall  be  charged  to  the  ac- 
count 'Other  Intangible  Street  Railway  Capital.'  If  any 
such  franchise  has  a  life  of  not  more  than  one  year  after  the 
date  when  it  is  placed  in  service,  it  shall  not  be  charged  to 
this  account  but  to  the  appropriate  accounts  in  'Operating 
Expenses,'  and  in  'Prepayments'  if  extending  beyond  the 
fiscal  year. 

"Payments  made  to  the  State  or  some  political  subdivision 
thereof  as  a  consideration  for  granting  an  extension  for 
more  than  one  year  of  the  life  period  of  a  franchise  shall  be 
classed  as  renewals.  Those  made  as  a  consideration  for 
franchises  or  extensions  thereof  covering  additional  territory 
to  be  operated  as  a  part  of  an  existing  system  shall  be  classi- 
fied as  betterments.  If  the  franchises  cover  separate  and 
distinct  new  enterprises,  the  payments  therefor  shall  be 
classed  as  original. 

"Note:  Annual  or  more  frequent  payments  in  respect  of 
franchise  must  not  be  charged  to  this  account,  but  to  the 
appropriate  tax  or  operating  expense  account." 

This  debars  a  public  service  corporation  which  falls  un- 
der the  commission's   supervision,   from  charging  to  the 


26o      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

account  "Franchise"  the  cost  of  obtaining  the  consent  of  the 
property  owners,  and  the  cost  of  the  legal  expenses  incurred 
in  connection  with  obtaining  the  grant.  Generally  speaking, 
however,  such  expenses  are  thought  to  be  properly  capital- 
ized under  the  heading  "Franchises,"  by  companies  not  con- 
trolled by  the  commission,  together  with  the  consideration 
for  the  contract  between  the  grantor  and  the  grantee,  i.e., 
the  amount  paid  to  the  state  or  political  subdivision  thereof. 
As  to  the  propriety  of  capitalizing  legal  expenses,  the  ques- 
tion remains  an  open  one ;  some  accountants  claim  that  such 
capitalization  is  faulty  whenever  the  company  which  is  the 
beneficiary  of  a  franchise,  has  a  permanent  legal  department 
as  part  of  its  administrative  organization. 

Any  other  cost  incident  to,  or  necessary  for,  the  enjoy- 
ment of  the  franchise,  such,  for  instance,  as  the  cost  of 
paving  between  tracks,  may  be  capitalized  in  some  other 
property  account,  such  as  Paving,  Track  and  Roadway,  etc. 

The  payment  to  a  municipality  of  a  portion  of  the  earn- 
ings from  operations,  in  accordance  with  the  terms  of  a 
franchise  grant,  is  considered  as  a  burden  of  the  asset  and 
cannot  enter  into  its  valuation. 


CHAPTER   XXTII 

INVESTMENTS 

Surplus  Capital 

That  part  of  the  capital  of  a  business  which  is  not  re- 
quired for  the  operation  of  the  enterprise,  may  be  invested 
outside  the  business  in  such  a  manner  as  to  provide  an  in- 
come at  least  equivalent  to  the  returns  which  a  private  in- 
dividual may  expect  to  receive  from  his  wealth  through 
ordinary  investment  channels ;  also,  profits  which  have  come 
in  the  business  and  are  not  needed  for  additions  and  better- 
ments, for  extension  of  the  field  of  operations,  or  for  dis- 
tribution to  the  interested  parties,  may  be  similarly  used. 
This  is  done  in  order  to  obtain  an  income  through  sources 
which  the  legitimate  pursuits  of  the  enterprise  do  not  afford. 
Finally,  all  available  funds  of  the  concern,  whether  capital 
or  the  result  of  operations,  may  be  invested  for  the  produc- 
tion of  the  income  necessary  to  fulfill  the  purpose  for  which 
the  concern  was  organized. 

Speculative  Investments 

Investments  may  be  temporary  or  permanent  in  nature. 
If  temporary,  they  may  have  an  undercurrent  of  speculation 
which  should  not  be  present  in  permanent  investments.  A 
business  concern  having  unemployed  funds,  may  afford  to 
invest  in  securities  selling  below  their  acknowledged  or  sup- 
posed worth,  hold  them  until  market  conditions  improve, 
and  sell  them  in  order  that  the  profits  may  be  realized.  But 
a  life  insurance  company,  whose  duty  it  is  to  obtain  for  the 

261 


262      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

present  and  secure  for  the  future  an  income  of  such  magni- 
tude that  it  will  not  only  exceed  the  cost  of  conducting  the 
enterprise  and  provide  for  such  losses  as  may  be  incurred, 
but  provide  as  well  for  the  largest  possible  refunds  of  pre- 
miums to  the  policy  holders  in  the  form  of  dividends,  cannot 
afford  to  buy  securities  the  fluctuations  of  which  may  be  due 
to  the  uncertainty  of  the  income  to  be  derived  from  them, 
or  to  the  problematic  character  of  their  value  in  the  event 
of  the  dissolution  of  the  companies  issuing  them. 

Temporary  investments  may  include,  among  other 
things,  securities  owned,  securities  purchased  on  margin, 
and  goods  purchased  owing  to  unusually  favorable  market 
conditions  and  held  either  to  be  used  by  the  concern  itself, 
if  conditions  make  it  advisable,  or  to  be  sold  if  prices  rise 
to  a  figure  which  will  guarantee  a  larger  profit  than  could 
be  had  if  the  goods  were  to  be  used  by  the  concern. 

Securities  purchased  for  speculative  purposes  should  be 
carried  on  the  books  at  their  original  cost,  that  is  to  say,  at 
their  market  value  on  the  day  of  the  purchase,  plus  fees  re- 
quired by  law  or  custom,  and  charges  for  services  rendered 
by  the  agents  who  attended  to  the  purchase.  When  pur- 
chased on  margin,  they  should  be  carried  at  cost,  that  is  to 
say,  market  value  on  the  day  of  purchase,  plus  charges  inci- 
dent thereto,  plus  subsequent  charges  made  by  brokers  for 
interest  on  the  proportion  of  the  cost  which  the  margin  does 
not  offset,  less,  if  such  accrue,  any  dividends  or  interest  col- 
lected by  the  broker  for  the  account  of  the  legal  owner  of  the 
securities.  To  offset  the  excess  of  the  original  cost  over  the 
amount  of  the  margin  and  the  subsequent  additions  to,  and 
deductions  from,  that  excess,  the  account  with  the  broker  is 
credited  or  debited,  as  the  case  may  be.  The  account  is  also 
debited  with  all  payments  made  to  the  broker  subsequent 
to  the  purchase.  Thus,  the  equity  of  the  speculator  is 
represented  by  the  difference  between  the  asset  and  liability 
accounts. 


INVESTMENTS 


263 


The  theory  which  holds  that  securities  carried  for  specu- 
lative purposes  should  be  stated  at  cost,  is  often  objected  to 
on  the  ground  that,  since  speculation  is  involved,  it  is  well 
to  make  the  Investments  account  reflect  the  fluctuations  of 
the  market.  It  cannot  be  forgotten,  however,  that  nothing 
which  has  not  been  sold  can  bring  profits,  and  that  the 
Profit  and  Loss  account  is  not  intended  to  reflect  what  the 
profits  or  the  losses  would  be  if  certain  transactions  had 
taken  place,  but  what  they  are  as  a  result  of  the  transactions 
which  have  taken  place. 

Goods  acquired  for  speculation  should  be  carried  at  cost 
of  purchase,  plus  charges  for  brokerage,  cartage,  storage, 
etc.,  and  plus  the  subsequent  cost  of  holding  them. 

Permanent  Investments 

The  word  "permanent"  when  applied  to  investments, 
does  not  mean  that  the  funds  are  invested  forever  in  one 
particular  thing,  but  that  if  the  sum  which  has  been  invested 
is  returned  at  the  expiration  of  the  term  of  the  investment, 
it  will  be  reinvested  at  once,  or  as  soon  as  may  conveniently 
be  done.    Permanent  investments  may  be  divided  as  follows  : 

1.  Loans  Secured  by  Bonds  and  Mortgages 

2.  Loans  Secured  by  Collateral 

a.  Time  Loans 

b.  Call  Loans 

3.  Investments  in  Bonds  of  Other  Companies 

4.  Investments  in  Stocks  of  Other  Companies 

5.  Investments  in  Real  Estate 

X.    Loans  Secured  by  Bonds  and  Mortgages 

The  account  representing  this  type  of  investments  is 
frequently  found  under  the  name  "Mortgages  Receivable." 
In  connection  with  the  word  "mortgage,"  as  usually  em- 
ployed, F.  A.  Cleveland  says  in  "Funds  and  Their  Uses" : 
"That  which  commonly  goes  in  the  security  market  as 


264 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


'mortg-age,'  is  a  misnomer ;  it  is  in  reality  a  credit  obligation 
secured  by  a  mortgage  *  *  *  in  fact,  if  one  held  only 
the  'mortgage'  or  security  contract,  it  would  be  of  little 
value.  The  promise  for  the  delivery  of  money  is  found  in 
a  'promissory  note'  or  other  evidence  of  debt.  The  mortgage 
is  only  a  collateral  contract  which  gives  to  the  creditor  a 
contract  of  lien  on  the  property  named  as  security  for  the 
payment  of  the  contract  of  credit." 

The  Mortgage  Contract 

The  indenture  pledging  property  to  secure  the  loan  re- 
ceived by  the  mortgagor  may,  or  may  not,  mention  the 
right  of  the  mortgagee  to  pay  delinquent  taxes  on  the 
property  pledged,  or  such  assessments  levied  on  the  prop- 
erty as  the  mortgagor  may  fail  to  pay,  or  fire  insurance 
premiums  which  he  is  in  duty  bound  to  pay  and  has  not 
paid;  nevertheless,  the  mortgagee  has  that  right,  and  such 
payments  made  by  him  will  be  presumed  to  be  for  the 
benefit  or  protection  of  the  pledge.  The  payments  thus  made 
will  be  added  to  the  principal  of  the  loan,  and  be  covered 
by  the  pledge,  precisely  as  if  they  had  been  part  of  the 
original  sum  loaned.  This  applies  also  to  the  necessary 
expenses  of  the  mortgagee  in  connection  with  foreclosure 
proceedings.  By  necessary  expenses  is  meant  disbursements 
which  cannot  be  construed  as  being  incurred  merely  for  the 
benefit  and  protection  of  the  mortgagee.  It  has  been  held 
by  courts  of  law  that  in  the  absence  of  stipulations  in  the 
pledge  to  the  effect  that  the  mortgagor  is  to  bear  cost,  the 
recording  fees  cannot  be  charged  against  him.*  This  is  due 
to  the  fact  that  the  recording  of  a  mortgage  is  principally  for 
the  protection  of  the  mortgagee,  since,  while  an  unrecorded 
mortgage  is  valid  as  between  the  contracting  parties,  it  is 
invalid  as  against  innocent  third  parties. 

To  insure  the  permanency  of  this  kind  of  investment, 

•  Simon  i:  Sewell,  64  Ala.  241. 


INVESTMENTS 


265 


the  mortgagee  has  been  given  the  right  to  refuse  repayment 
of  the  sum  loaned  until  the  date  mentioned  in  the  promissory 
note.  To  secure  the  recovery  by  the  leaner  of  the  principal 
sum  loaned,  of  the  advances  made  by  him  for  the  protection 
of  the  property  pledged,  and  of  the  interest  accrued  there- 
under, the  states  of  the  Union  have  enacted  statutes  con- 
cerning the  steps  which  the  mortgagee  must  take  to  enter 
the  premises  or  to  satisfy  his  claim  through  foreclosure 
proceedings. 

Mortgage  Interest 

In  regard  to  the  income  from  mortgage  loans,  it  should 
be  noted  that  it  does  not  accrue  from  the  date  of  the  mort- 
gage, but  from  the  date  at  which  the  money  was  paid  to  the 
mortgagor;  that  if  no  rate  of  interest  is  mentioned,  the 
legal  rate  prevails ;  that  if,  peradventure,  the  bond  or  prom- 
issory note  does  not  mention  interest,  while  the  mortgage 
does,  interest  will  be  allowed  at  the  legal  rate ;  that  interest 
after  the  maturity  of  the  obligation  and  default  thereon,  is 
chargeable  to  the  mortgagor  if  the  instrument  so  stipulates 
or  if  it  carries  interest  "until  paid." 

The  amount  which  will  be  loaned  on  bonds  and  mort- 
gages depends  generally  upon  the  margin  considered  to  be 
safe.  Some  concerns  will  loan  on  first  mortgages  as  much 
as  80%  of  the  appraised  value  of  the  property  to  be  pledged 
while  others  will  loan  only  60%.  In  the  first  instance  the 
margin  would  be  stated  as  20%  ;  in  the  second,  at  40%. 

Accounting  Procedure  and  the  Mortgage  Register 

Accounting  for  this  class  of  investments  presents  no 
difficulty  so  far  as  the  general  ledger  is  concerned,  since  it 
consists  merely  in  recording  the  amount  loaned,  the  ad- 
vances made  for  the  account  of  the  mortgagor,  either  at  the 
time  of  the  loan  or  subsequently,  and  the  amount  collected 
at  maturity  of  the  investment.    But  a  subsidiary  book  which 


266      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

will  give  all  the  information  that  may  be  required,  is  a  more 
complex  matter.  For  each  individual  mortgage  there  must 
be  known,  besides  the  name  of  the  mortgagor  and  the 
amount  of  the  loan :  the  date  when  the  mortgage  was  given 
and  its  maturity ;  the  location  and  the  general  description  of 
the  premises  mortgaged ;  the  state  and  county,  and  the  book 
and  page,  in  which  the  mortgage  was  recorded ;  the  interest 
rate  and  date;  the  number,  the  term,  the  amount,  and  the 
expiration  of  the  policy  of  fire  insurance  which  protects  the 
buildings,  the  amount  of  the  premium  paid,  the  name  of  the 
company  in  which  the  property  is  insured,  and  the  name  of 
the  party  who  is  to  pay  the  premiums ;  the  appraised  value  of 
the  land  and  of  the  buildings ;  the  amount  of  principal  repaid 
if  the  mortgage  provides  for  gradual  extinction,  and  the 
amount  of  interest  accrued  and  due,  as  well  as  the  amount 
paid. 

Figure  38  will  show  how  the  information  required  may 
be  conveniently  condensed  without  detracting  from  the 
lucidity  of  the  record.  Any  other  data  which  may  be  needed 
in  regard  to  possible  assignments  of  the  mortgage,  may  be 
inserted  on  the  left  side  of  the  folio. 

The  Nature  of  Security 

"When  a  debtor  delivers  to  his  creditor  an  evidence  of 
indebtedness  with  the  intention  that  it  become  additional  se- 
curity for  his  personal  existing  obligation,  it  becomes  merely 
concurrent  security,  and  is  only  designed  to  increase  the 
means  of  the  creditor  to  realize  the  principal  debt  which  it 
is  given  to  secure."* 

"There  are  three  kinds  of  security:  the  first,  a  simple 
lien ;  the  second,  a  mortgage,  passing  the  property  out  and 
out ;  the  third,  a  security  intermediate  between  a  lien  and  a 
mortgage,  viz.,  a  pledge."t     The  holder  of  a  lien  has  no 


•  Osborne  v.  Stringham,  44  S.  D.  593,  598;  57  N.  W.  776- 
t  Halhday  v.  Holgate,  L.  R.  3  Exch.  a^  30a. 


INVESTMENTS 


267 


right  to  sell  the  property  which  he  holds  as  security;  he 
must  be  content  to  retain  it  until  his  claim  is  satisfied. 

"A  mortgage  is  but  a  conveyance  with  a  clause  of  de- 
feasance; it  is  something  more  than  a  lien;  it  is  the  g^ant 
of  an  estate  as  specific  security  for  the  money  loaned."*  The 
holder  of  a  pledge  has  no  title  of  any  kind  to  the  thing 


OsAz 


I  Qrvcn  . 
\Duc_ 


Record 


Interest 


Courrty_ 

Book 

I  Page 

Rate 

Date 


INSURANCE' 

Company 

Term 

BolicyJte^ 


Expiration 

Amount  ♦ 

Premium  • 

By  whom  payable. 

APPRAISALS' 
Land  *. 


Buildings  ♦ 

Name  of  Apprais«r_ 
Date  of  Appraisals. 


Ne. 


Ctty_ 
5tata_ 


CountrvL. 
Street. 


Diagram  and  dimensions  of  property  mcrlgaged. 


Amount  t 
Mortgager- 


Bzmarks- 


Name 

A<ldnB3&- 


Principal                                              1         irneneoT 

^ 

i                             ^'■ 

n 

1 

Dafe 

Explanation 

Loan 

Mance 

1   Date 

Explanation 

Loan  JAdvancesJ  IWe 

Kcniidfxilkau 

1 

1 

1 

1 

1 

1 

1 

1 

1 

Figure  38.    Subsidiary  Ledger  for  Secured  Loans 


pledged,  but  has  an  implied  right  to  sell  it  on  the  day  of  the 
default  of  the  pledgor.  "The  authorities  show  that  the 
difference  between  a  pledge  or  pawn  of  personal  chattels 
and  a  mortgage  of  them  is,  that  a  mortgage  passes  the  whole 
legal   interest  and  property   from  the  mortgagor  to  the 


*  Dateman's  Appeal,  127  Pa.  St.  348;  17  AtL  1086,  ixock 


268      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

mortgagee,  and  possession  by  the  mortgagee  is  not  essential 
to  create  his  title,  and,  generally  speaking,  is  inconsistent 
with  such  a  title,  while  a  pledge  transfers  only  personal 
property  in  the  thing  pledged,  the  general  property  con- 
tinuing in  the  pledgor.  The  pledgee's  right  is  not  complete 
until  he  has  obtained  possession,  and  his  right  or  special 
property  is  to  hold  the  pledge  as  security  for  the  debt  or 
engagement  of  the  pledgor,  and  on  default  on  the  day  ap- 
pointed for  payment  or  performance,  to  sell  the  pledge.  Se- 
curities for  money  and  negotiable  instruments  may  be  given 
in  pledge,  and  the  addition,  as  there  is  in  the  agreement  here, 
of  an  express  power  to  sell  on  default,  will  not  change  what 
would  have  been  a  pledge  into  a  mortgage."* 

The  foregoing  describes  fully  the  nature  of  the  asset 
"loans  on  collateral,"  and  differentiates  between  investments 
in  which  the  title  to  the  security  pledged  is  in  the  loaner, 
although  it  carries  a  defeasance  clause,  and  the  investments 
in  which  the  title  to  the  pledge  remains  in  the  pledgor. 

2.    Loans  Secured  by  Collateral 

Time  loans  are  made  for  a  specified  period  of  time,  and 
cannot  be  repaid  before  maturity  without  the  consent  of  the 
loaner;  that  consent  may  be  given  without  consideration, 
or  in  consideration  of  the  payment  of  a  "bonus"  calculated 
on  the  basis  of  equated  time. 

Call  loans  are  not  made  for  any  specific  period,  and  are 
repayable  at  the  option  of  the  beneficiary  or  upon  the  de- 
mand of  the  loaner. 

The  securities  pledged  under  either  class  of  loans  may 
consist  of  bonds  or  stocks,  or  both,  or  even  of  goods  de- 
posited in  a  warehouse,  as  evidenced  by  the  pledge  of  the 
storage  receipt.  The  pledge  is,  in  any  case,  of  a  market 
value  superior  to  the  loan  made  thereunder.  The  amount 
of  the  margin  depends  upon  the  policy  of  the  loaner  as  to 

•Dateman's  Appeal,  127  Pa.  St.  348;  17  Atl.  1086,  iioo. 


INVESTMENTS 


269 


what  he  considers  safe.  It  is  understood  between  the  con- 
tracting parties  that  the  securities  pledged  may  be  with- 
drawn at  any  time  by  the  party  who  has  title  to  them,  and 
replaced  by  others  equally  acceptable  to  the  pledgor.  It  is 
also  understood  that  if  the  market  value  of  the  pledge  falls 
below  the  margin  represented  by  the  difference  between  the 


N 

A 

«a_ 

rlrlncA^ 

Amount'                                           Dates; 

1 oan    A                                                              Loan 
Margin                                   %                          Maturity 
ln+«rr«%t    r7i+»                          *A                              Inte.PR^ 
Remarks; 

Date 

Description 

Quan- 
tity 

Market 
Value 

Total 
Value 

Date 

Oesription 

Quan- 
tity 

Market 
Vfelue 

Total 
Vblue 

Figure  jp.    Record  of  Collateral  Pledged  for  Loans 


market  value  of  the  original  securities  on  the  day  of  the 
loan,  and  the  amount  loaned,  the  pledgee  may  call  upon  the 
pledgor  for  additional  security  sufficient  to  make  up  the 
difference,  or,  if  it  is  a  call  loan,  for  additional  security  or 
for  repayment.  In  case  of  default  the  pledgee  may  sell  the 
securities,  apply  the  proceeds  to  liquidate  the  indebtedness 


270      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

of  the  pledgor,  and,  if  any  excess  remains,  return  this  to  the 

pledgor. 

The  method  of  keeping  account  of  the  collateral  pledged 
under  either  time  or  call  loans,  is  illustrated  by  Figure  39. 
Exchanges  of  securities  are  recorded  by  merely  crossing  off 
the  particular  items  which  have  been  removed,  and  entering 
under  the  proper  date  the  securities  which  have  taken  their 
place. 

3.    Investments  in  Bonds  of  Other  Companies 

The  accounting  treatment  here  depends  absolutely  upon 
the  purpose  of  the  investment. 

If  an  "investment  house"  buys  bonds,  it  is  for  the  pur- 
pose of  holding  them  until  such  time  as  they  can  be  dis- 
posed of  advantageously  among  customers  of  the  house,  or, 
if  more  profitable,  resold  in  the  open  market.  The  only 
question  at  issue  in  either  case  is  one  of  profit,  and  it  is 
evident  that,  since  par  value  is  purchased  and  sold,  with  a 
variation  in  the  amount  of  discount  gained  or  premium 
suffered,  the  one  important  thing  from  the  theoretical  stand- 
point is  to  determine  precisely  that  variation. 

Hence,  so  far  as  the  general  ledger  is  concerned,  an  ac- 
count with  the  par,  and  one  with  the  premiums  and  dis- 
counts for  every  class  of  bonds  acquired,  will  satisfy  the 
requirements.  The  account  with  par  is  merely  an  inventory 
account  reflecting  at  all  times  the  unsold  portion  of  the 
principal;  the  account  with  premiums  and  discounts  is  a 
complex  account  which,  in  order  to  show  profits  and  losses, 
requires  the  application  of  the  inventory  of  that  part  of  the 
net  amount  of  the  account  which  applies  to  the  principal 
unsold. 

The  Interest  Account 

Premiums  and  discounts  must  be  carefully  distinguished 
from  the  interest  purchased,  if  any.    Interest  which  has  ac- 


INVESTMENTS 


271 


crued  on  the  bonds  at  the  time  of  their  purchase  is  under 
no  conditions  to  be  considered  as  part  of  the  cost  of  the 
investment.  It  must  be  evident  to  the  student  of  accounting 
that  the  amount  paid  for  interest  accrued  on  bonds  acquired 
does  not  represent  either  principal  or  income  of  the  pur- 
chaser. It  merely  expresses  the  amount  of  the  earnings  of 
the  vendor  which  the  vendee  will  receive  on  the  first  interest 
date  and  must  refund,  to  the  vendor  in  anticipation;  or  if  the 
bonds  are  acquired  from  the  company  responsible  for  their 
issue,  it  represents  only  that  part  of  the  interest  receivable 
at  the  first  interest  date,  which  the  purchaser  has  not  earned 
and  which  the  issuing  company  has  not  incurred.  As  a 
consequence,  interest  accrued  on  bonds  acquired,  no  matter 
what  the  purpose  of  the  investment  may  be,  is  nothing  more 
than  interest  purchased,  for  which  a  special  account  must  be 
raised.  This  account  will  be  closed,  at  the  first  interest  date, 
by  crediting  to  it  that  part  of  the  interest  receipts  which 
was  earned  by  the  bonds  before  they  were  purchased,  and 
which  formed  part  of  the  purchase  price.  It  is  evident 
that  this  account  does  not  reflect  either  a  gain  or  a  loss. 

The  interest  received  on  bonds  by  an  investment  house 
is,  of  necessity,  income  on  the  capital  invested,  and  should 
under  no  conditions  be  considered  as  reduction  of  the  cost 
of  the  investment. 

If  a  business  concern  buys  bonds  as  temporary  producers 
of  income,  the  only  logical  way  of  treating  the  account  is  to 
express  the  bonds  at  cost.  The  question  of  amortization  or 
of  accumulation  of  cost  to  par  cannot  arise  in  this  particular 
case,  since  it  never  was  intended  to  hold  the  bonds  until 
maturity.  The  receipts  of  interest  will  send  to  the  earning 
account  "Interest  on  Bonds,"  an  amount  which  will  bear 
the  rate  of  income  which  the  concern  expected  on  the  cost 
shown  by  the  bond  account.  When  the  securities  are  sold, 
the  account  with  principal  will  reflect  the  profit  or  the  loss 
made  on  the  sale  of  the  ledger  asset. 


272      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

Relation  of  Cost  to  Income 

If,  in  accordance  with  the  purpose  for  which  it  was 
created,  a  concern  purchases  long-term  investments  in  order 
that  the  rate  of  income  which  they  produce  may  be  guaran- 
teed for  an  extended  future,  then,  and  then  only,  does  the 
accountant  face  the  question  of  amortization  of  that  part  of 
the  cost  which  will  not  be  repaid  to  the  purchaser  at  ma- 
turity, or  the  question  of  accumulation  of  that  excess  of  par 
over  cost  which  will  be  received  at  maturity  of  the  invest- 
ment. 

This  class  of  investment  cannot  be  recorded  otherwise 
than  at  the  cost  at  the  time  of  acquisition.  By  cost  is  meant 
only  par  plus  premium  or  less  discount,  as  the  case  may  be, 
and,  for  reasons  which  will  become  obvious  as  soon  as  the 
theory  of  amortization  has  been  expressed,  cannot  be  made 
to  contain  interest  purchased,  brokerage,  stamp  tax,  etc., 
etc. 

If  the  value  of  the  asset  is  stated  at  cost,  and  cost  is  less 
than  par,  it  is  evident  that  at  maturity  of  the  investment,  the 
amount  of  the  principal  received  being  credited  to  the  asset 
account,  the  credit  will  exceed  the  debit,  unless  in  the  interim 
steps  have  been  taken  to  accumulate  cost  to  par.  Conversely, 
if  cost  is  greater  than  par,  and  at  maturity  of  the  invest- 
ment the  amount  of  principal  received  is  credited  to  the 
asset  account,  the  debit  will  exceed  the  credit,  unless  in  the 
interim  steps  have  been  taken  to  amortize  the  portion  of  cost 
in  excess  of  par  value. 

Now,  since  bonds  assure  to  their  holders  an  interest  an- 
nuity during  the  life  of  the  instruments  of  credit,  and  a  re- 
version of  principal  at  maturity,  if  a  bond  with  a  nominal 
return  of,  say,  5%  has  been  acquired  at  a  price  to  produce 
4%,  and  another  bond  with  a  nominal  return  of  4%  has 
been  acquired  at  a  price  to  produce  5%,  it  is  plain  that  in  the 
first  instance  the  cash  interest  income  received  on  the  par 
reversion  value  has  been  g^reater  than  the  expected  income 


INVESTMENTS 


273 


on  the  outlay,  while  in  the  second  instance  it  has  been 
smaller.  Submitting  these  facts  to  rigid  analysis,  we  see 
that  the  excess  of  cash  income  produced  by  bonds  acquired 
at  a  premium,  represents  in  reality  a  periodical  return  of 
cost  over  par,  that  is  to  say,  a  reduction  of  cost,  and  that  the 
excess  of  effective  income  produced  by  bonds  acquired  at  a 
discount  represents  in  reality  a  periodical  accretion  of  cost 
to  par. 

Proceeding  further,  if  5%  on  par  has  been  received  in 
cash  as  interest  on  a  bond  acquired  at  a  price  which  would 
produce  4%  on  cost,  the  income  on  the  investment  will  not 
be  accurately  stated  until  the  earning  account  to  which  the 
cash  return  has  been  credited,  is  relieved  of  the  difference. 
And  if  3%  on  par  has  been  received  in  cash  as  interest  on 
a  bond  acquired  at  a  price  which  would  produce  4%  on 
cost,  the  income  on  the  investment  will  not  be  accurately 
stated  until  the  earning  account  to  which  the  cash  return 
has  been  credited  is  increased  by  the  difference. 

What  that  difference  will  be  found  to  be  in  either  case, 
depends  upon  whether  we  are  satisfied  with  near-accuracy, 
or  only  with  absolute  accuracy.  In  the  first  instance,  it  will 
be  sufficient  to  divide  the  total  premium  or  the  discount  into 
as  many  equal  units  as  there  are  interest  periods  during  the 
remainder  of  the  life  of  the  bonds.  In  the  second  instance 
we  shall  have  to  compute  the  exact  income  on  the  book 
value  of  the  investment  as  it  stood  at  the  beginning  of  each 
successive  period,  deduct  that  amount  from  the  interest  re- 
ceived, and  apply  the  difference  as  a  reduction  from,  or  as  an 
addition  to,  the  cost. 

The  following  examples  will  serve  to  illustrate  the  dif- 
ferent results  obtained  under  the  two  methods  of  treatment. 
In  Example  A  the  premium  has  been  amortized  in  equal 
amounts  during  the  life  of  the  bonds,  extending  from  the 
date  on  which  they  were  purchased  to  the  date  of  their 
tnaturity. 


274      '^^■^    THEORY    OF    THE    ASSET    ACCOUNTS 

Example  A 
Investment 

5%  Bonds  of  the  Millstone  Co.,  payable  May  i,  1914.     Interest  pay- 
able May  and  November  i.    Acquired  to  produce  4%.    Par,  $50,000.00. 


Interest  on  Investment 

Principal 

Date 

Nominal 
Return 

Period- 
ical 

Amor- 
tization 

Income 

Dr. 

Cr. 

Balance 

Remarks 

May   I,    1909 
Nov.   I,  1909 
May   I,   1910 
Nov.  I,  1910 
May   I,   191 1 
Nov.  I,  191 1 
May  I,   1912 
Nov.  I,  1912 
May   1,  1913 
Nov.  1,   1913 
May    I,  1914 

$52,245.64 

Cash 

$1,250.00 
i,25aoo 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 

$224-57 
224.56 
224.57 
224.56 
224.56 
22457 
224.56 
224.56 
224.57 
224.56 

$1,025.43 
1,025.44 
1,025.43 
1,025.44 
1,025.44 
1,025.43 
1,025-44 
1,025.44 

1,025.43 
1,025.44 

$224-57 
224.56 

224-57 
224.56 
224.56 
224.57 
224.56 
224.56 
224.5- 
224.56 
50,000.00 

$52,021.07 
51,796-51 
51,571-94 
51,347-38 
51,122.82 
50,888.25 
50,673.69 
50,449-13 
50,224.56 
50,000.00 

$12,500.00 

$2,245.64 

$10,254.36 

$52,245.64 

$52,245.64 

In  Example  B  which  follows,  the  premium  has  been 
amortized  in  accordance  with  the  theory  of  the  accountancy 
of  investments. 


Example  B 
Investment 

5%  Bonds  of  the  Millstone  Co.,  payable  May  i,   1914.     Interest  pay- 
able May  and  November  i.    Acquired  to  produce  4%.    Par,  $50,000.00. 


Interest 

Principal 

Date 

Nominal 

5% 
on  Par 

Effective 
on  cfost 

Amor- 
tization 
of  Cost 
to  Par 

Dr. 

Cr. 

Balance 

Remarks 

May    1,  1909 
Nov.   1,  1909 

$1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 
1,250.00 

$1,044.91 
1,040.81 
1,036.63 
1,032.36 
1,028.01 
1,023.57 
1,019.04 
1,014.41 
1,009.71 
1,004.91 

$205.09 
209.19 
213-37 
217.64 
221.99 
226.43 
230.96 
235-59 
240.29 

245-09 

$52,245.64 

$205.09 
209.19 
213-37 
217.64 
221.99 
226.43 
230.96 
235-59 
240.29 
245-09 
50,000.00 

$52,040.55 
51,831.36 
51,617-99 
51,400.35 
51,178.36 
50,951-93 
50,720.97 
50,485.38 
50,245.09 
50,000.00 

Cash 
Interest 

May    I,  1910 

Nov.    1,  X910 

„ 

May    I,  igii 

„ 

Nov.   1,  191 1 

„ 

May    1,  1912 

„ 

Nov.   I,  1912 
May    1,  1913 

" 

Nov.   1,  1913 

„ 

May    T,  1914 

„ 

Cash 

$12,500.00 

$10,25436 

$2,245.64 

$52,245.64 

$52,245.64 

INVESTMENTS  275 

When  the  figures  given  in  Example  B  are  analyzed 
carefully,  it  is  seen  that  the  periodical  amortization  result 
represents  a  uniform  amount  of  $205.09  (which  is  the  dif- 
ference between  the  nominal  cash  interest  received,  and 
the  effective  amount  expected  as  income)  set  aside  at  every 
interest  date,  together  with  interest  at  2%  semiannually 
(4%  annually)  earned  by  the  amounts  previously  set  aside, 
and  deducted  from  the  cost  of  the  investment  at  the  end 
of  the  period. 

Hence,  the  theory  of  amortization  of  premiums  on 
bonds  bearing  interest  semiannually,  rests  upon  the 
assumption  that  the  amount  of  cash  representing  the 
difference  between  the  nominal  and  the  effective  rate  at 
the  time  of  the  first  receipt  of  interest,  is  deposited  twice 
a  year  at  compound  interest,  in  order  that  at  maturity  of 
the  investment  a  fund  equal  to  the  premium  may  be 
obtained. 

To  prove  whether  or  not  this  is  true,  let  us  assume 
that,  instead  of  periodically  reducing  the  cost  of  the  bonds, 
we  allow  the  original  cost  to  remain  undisturbed  until 
maturity,  and  that  we  deposit  twice  a  year  in  a  special 
fund  earning  compound  interest  at  2%  semiannually,  the 
amount  of  cash  received  for  interest  on  the  par  value  in 
excess  of  the  expected  income.  We  then  obtain  the  table 
given  on  the  following  page,  which  reflects  faithfully  the 
entries  made  in  the  ledger  accounts  which  will  be  affected 
by  the  transactions. 

The  illustration  given  is  all  the  more  interesting  be- 
cause it  shows  that  the  net  result  of  the  cash  transactions 
incident  to  the  purchase,  the  interest  earnings,  and  the 
sale  of  the  investment  from  May  i,  1909,  to  May  i,  1914, 
has  been  to  increase  the  wealth  of  the  investor,  as  repre- 
sented by  cash,  in  the  amount  of  $10,449.10,  which  is 
precisely  the  amount  which  he  expected  his  investment 
to  produce  in  five  years. 


2^6 


THE  THEORY  OF  THE  ASSET  ACCOUNTS 


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INVESTMENTS  277 

On  the  other  hand,  an  analysis  of  the  cost  transactions 
reflected  by  Examples  "A"  and  ''B,"  that  is  to  say,  the 
"nearly  accurate"  and  the  "absolutely  accurate"  methods, 
shows: 

Cash  Disbursements: 
May  I,  1909 

Paid     for     investment     in 

bonds    $52,245.64 

Cash  Receipts: 

Nov.  I,  1909,  to  May  i,  1914 

Received  for  interest $12,500.00 

May  I,  1914 

Received — P  a  r  value  of 
bonds  — 50,000.00    62,500.00 

Net  increase  of  cash  as  a 
result  of  the  investment, 
as  corroborated  by  the 
income  accounts  from 
Nov.  I,  1909,  to  May  i, 
1914  $10,254.36 

So  far  as  cash  is  concerned,  the  difference  between  the 
two  sets  of  results,  is  nothing  more  than  the  interest 
earned  by  the  premium  redemption  fund  created  under 
Example  C,  i.e.,  $194.74.  As  to  the  difference  in  the 
income,  it  is  due  to  the  fact  that,  in  Example  B,  the  in- 
terest supposedly  earned  by  the  amount  of  $205.09  is 
deducted  from  an  asset,  while  in  Example  C  it  is  added 
to  an  asset.  Principles  of  accounting  state  that  if  an  asset 
is  deducted  from  another,  the  income  which  originates 
from  the  asset  thus  deducted,  is  compensated  by  the  de- 
crease of  the  other  asset,  while,  if  the  asset  arising  from 
the  receipt  of  income  is  recorded,  the  income  must  also 
be  shown. 


278      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

We  will  use  the  same  examples  in  connection  with  dis- 
counts. 

In  Example  D  the  discount  has  been  accumulated  in 
equal  amounts  during  the  life  of  the  bonds. 

Example  D 

3%  Bonds  of  the  Millstone  Co.,  payable  May  i,  1914.     Interest  pay- 
able May  and  November  i.    Acquired  to  produce  4%.    Par,  $50,000.00. 


Interest 

Principal 

~ 

Date 

Nominal 

Rate 

Cash 
Receipts 

Applied 
to  Reduce 
Dis- 
counts 

Total 
Income 

Dr. 

Cr. 

Balance 

Remarks 

May    I,  1909 
Nov.   I,  1909 
May    I,  1910 
Nov.  I,  1910 
May    1,  1911 
Nov.  1,  1911 
May    I,  1912 
Nov.  I,  1912 
May    I,  1913 
Nov.  I,  1913 
May   1,  1914 

$974.57 
974-56 
974-57 
974-56 
974-56 
974-57 
974-56 
974-56 
974-57 
974-56 

$47,754-36 
224-57 
224-56 
224-57 
224.56 
224.56 
224-57 
224.56 
224-56 
224.57 
224.56 

Cash 

$750.00 
750.00 
750-00 
750.00 
750.00 
750.00 
750-00 
750.00 
750.00 
750.00 

$224-57 
224.56 

224-57 

224.56 
224.56 
224.57 
224.56 
224.56 
224-57 
224.56 

$47,978.93 
48,203.49 
48,428.06 
48,652.62 
48,877-18 
49,101-75 
49,326.31 
49,550.87 
49,775-44 
50,000.00 

$50,000.00 

Cash 

$7,500.00 

$2,245-64 

$9,745-<i* 

$50,000.00 

$50,000.00 

The  phase  of  the  theory  of  accounts  known  as  "accoun- 
tancy of  investments"  is  much  more  readily  understood  by 
the  student  when  applied  to  premiums  than  when  applied 
to  discounts.  And  yet,  the  accounting  principle  is  the  same 
and  is  equally  plain  from  either  point  of  view.  On  the  one 
hand,  the  periodical  recovery,  under  the  outward  appearance 
of  "income,"  of  the  portion  of  the  "cost"  of  the  asset  "in- 
vestments" which  exceeds  "par,"  necessitates  the  periodical 
reduction  of  the  asset  and  of  the  income.  On  the  other 
hand,  the  periodically  increasing  value  of  the  asset  in  its 
evolution  from  "cost"  to  "par,"  can  only  be  expressed  by  a 
corresponding  increase  of  income. 

In  Example  E  the  discounts  have  been  accumulated 
scientifically. 


INVESTMENTS 


Example  E 


279 


3%  Bonds  of  the  Millstone  Co.,  payable  May  i,  1914.     Interest  pay- 
able May  and  November  i.    Acquired  to  produce  4%.    Par,  $50,000.00. 


Interest 

Principal 

Date 

Nominal 

3% 
on  Par 

Effective 
on  (fost 

Accum- 
ulation 
to  Par 

Dr. 

Cr. 

Balance 

Remarks 

May    I,  1909 
Nov.   I,  1909 

$750.00 
750.00 
750.00 
750.00 
750.00 
750.00 
750.00 
750-00 
750.00 
750.00 

$955.09 
959-19 
963-37 
967-64 
971.99 

976.43 
980.96 
985-59 
990.29 
995-09 

$205.09 
209.19 
213-37 
217.64 
221.99 
226.43 
230.96 
235-59 
240.29 
245-09 

$47,754-36 
205.09 
209.19 
213-37 
217.64 
221.99 
226.43 
230.96 
235-59 
240.29 
245-09 

$47,959-45 
48,168.64 
48,382.01 
48,599-65 
48,821.64 
49,048.07 
49,279.03 
49,514.62 
49.754-91 

Cash 

May    I,  1910 

Nov.  1,  1910 

« 

May    I,  1911 
Nov.  1,  1911 

„ 

May    I,  IQ12 

« 

Nov.   I,  1912 

M 

May    I,  1913 

« 

Nov.   I,  1913 

« 

May    I,  1914 

$50,000.00 

Cash 

$7,500.00 

$9,745-64 

$2,245.64 

$50,000.00 

$50,000.00 

Enough  has  been  said  on  the  subject  of  premiums  and 
discounts  to  show  that  the  differences  developed  by  the 
sundry  methods  of  treating  discounts  and  premiums  are 
not  very  important,  in  so  far  at  least  as  small  investors 
are  concerned. 

As  to  large  investors,  it  would  seem  that  their  policy 
being  to  invest  in  such  a  manner  as  to  obtain  a  stated 
rate  of  income,  nothing  will  satisfy  their  requirements 
but  the  method  which  will  make  the  income  account  re- 
flect the  effective  (or  expected)  rate  of  income  which  they 
receive. 

Courts  of  law  are  not  unlikely  to  frown  at  scientific 
methods  of  amortizing  or  accumulating  bonds  to  par  in 
connection  with  the  interests  of  life-tenants  and  re- 
maindermen. The  following  quotation  from  the  Cyclo- 
paedia of  Law  and  Procedure  will  point  out  how  divergent 
opinions  are  in  respect  to  premiums  and  discounts: 

"It  is  very  generally  held  that  if  a  testator  leaves 
bonds   which   he   owns   to   trustees,   with   direction   or 


28o      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

authority  to  hold  the  same,  paying  the  interest  to  certain 
persons  for  life,  with  remainder  over,  the  fact  that  such 
bonds  are  worth  a  premium  at  and  after  his  death,  will 
not  warrant  the  trustees  in  retaining  any  portion  of  the 
interest  for  the  benefit  of  the  remaindermen.^  But  in 
the  case  of  bonds  purchased  at  a  premium  by  the  trustees 
after  the  testator's  death,  the  cases  are  in  hopeless  conflict. 
In  some  states  it  is  held  that  such  premiums  are  to  be  charged 
to  principal,  and  not  to  income,  and  a  trustee  is  not  justified 
in  withholding  a  part  of  the  income  to  meet  a  diminution  of 
principal  which  may  not  ever  take  place.^  In  other  states 
the  rule  is  laid  down  that  where  trust  funds  are  invested  in 
bonds  running  for  a  term  of  years  and  purchased  at  a 
premium,  in  the  absence  of  a  clear  direction  in  the  will  to 
the  contrary,  such  a  proportionate  deduction  should  be  made 
from  the  nominal  interest  as  will,  at  the  maturity  of  the 
bonds,  make  good  the  premium  paid,  and  preserve  the 
principal  of  the  fund  intact  at  maturity.  This  is  called  the 
sinking  fund  rule.^" 

Investment  Accounting 

A  great  deal  has  been  said  about  the  difficulty  of  the 
theory  of  the  accountancy  of  investments.  Still,  if  the 
principle  is  understood,  nothing  is  simpler  than  to 
amortize  bonds  when  the  cost,  the  nominal  rate  on  par, 
the  effective  rate  on  cost,  the  interest  periods,  and  the 
life  of  the  securities  are  known. 

r«,^!=^?","l^*'*'"*  '^'■"^^T^*^-  Co.'s  Appeal,  80  Conn.  540;  69  Atl.  360;  Show  v. 
Cordis  143  Mass,  443;  9  N.  E.  794;  Hemenway  v.  Hemenway,  134  Mass.  4^6;  etc. 
,8n-  ,^'t  'r  T'  '^^  ^^-  ^57;  20  S.  W  778;  14  Ky.  L.  Rep.  ^s;  40  aJT  St.  Rep. 
1^:1,^  h  ^-  ^-  '7.3;  A"  '■^  Penn  Gaskell,  208  Pa.  St.  Super  Ct.  526,  holding 
T,AiH  to  th^.  rf  direction  m  a  will  that  "the  net  income  of  certain  funds  is  to  be 
Itkt  fnr  tifJl,  K-r!'  ^°f^  "?.*  PI''""*  ^'"y  deduction  from  such  income  to  pro- 
rnve,t^pm.  P,°^^'''ll'ty  «*  '"ss  by  the  principal  on  account  of  premiums  paid'^for 
investments;  In  re  Furney,  12  Phila.  Pa    130 

New'Sknd'Tr7.^To\r-TPf^°"'"'  ^^a.^""""  555!  65  Atl.  968;  Massachusetts- 
XNew   c-ngiand    Jrust   Co.   v.   Eaton,   140   Mass.   532;   4   N.    E    6o-    <;4  Am     Ren    sat- 

Ste:e;^r',7~N"Y"!i'r.  L  N°"?«'  't?"-  K  ?<!  S^^f  7o  Atl.  ^■,  '^ew  York^l/n''^^ 
S,,3  V.  »i;"  .i,"*'^  '  ^  ^-  ^-  3S8  (modifying  iii  5l.  Y.  App.  D.  773;  98  N.  Y. 
m1??  ,  ^^^i*J-=  °^'i.^'"  "ses  quoted.  B-jt  see  matter  of  N.  Y.  L.  Ins  etc  Co  24 
t^ut?ee''in  "hi'^e^xeV^ciy^'oVv  '  °'  ^.^'".>  '^^  "^'"«  «*  securities  purchased  by  1 
Mcretion  as  the  case  miv  h\ 'o^i '^"'"^^^^  "^""'"^  8°  *"  ^^^  diminution  or 
Mntrirv  in^Ltinn  ™^.%T'^-^^'i°ir*^^  capitel,  and  not  of  the  income,  unless  a 
contrary  intention  must  be  implied  from  the  trust  instrument.  - 


INVESTMENTS  281 

As  to  accounting  problems  based  on  this  subject, 
which  C.  P.  A.  candidates  are  asked  to  solve  at  examina- 
tions, they  uniformly  state  the  par  value  of  the  bonds 
acquired,  the  nominal  rate,  the  effective  rate,  the  interest 
periods,  and  the  life  of  the  bonds,  and  require  the  finding 
of  the  cost.  No  candidate  should  fail  to  meet  the  test  if 
he  really  understands  the  theory  of  amortization.  He  re- 
quires no  algebraic  formulae,  and  no  more  advanced 
knowledge  of  mathematics  than  familiarity  with  division, 
subtraction,  and  addition. 

Considering  the  meaning  of  the  transactions  which 
will  take  place  at  the  maturity  of  the  securities,  he  will 
see  at  once  that  there  will  be  received  by  the  investor: 

1.  The  par  value  of  his  investment. 

2.  The  last  instalment  of  the  premium  annuity  re- 

payable in  as  many  periods  as  the  bonds  have  to 
live  between  the  date  of  the  purchase  and  that 
of  the  maturity. 

3.  The  effective  (or  expected)  rate  on  cost. 

Items  2  and  3  are  included  in  the  receipt  of  the 
nominal  rate  on  par  receivable  at  the  same  time  as  the 
principal. 

Adding  the  proceeds  of  principal  at  the  end  of  the  last 
period,  to  the  proceeds  of  interest  received  at  maturity, 
at  the  nominal  rate,  a  sum  is  obtained  which  is  composed 
of  the  whole  cost  (i.e.,  100%)  at  the  beginning  of  the 
said  last  period,  plus  the  effective  interest  on  cost. 

Dividing  the  sum  of  the  cost  of  the  principal  at  the 
end  of  a  period,  inflated  by  the  nominal  interest  return, 
by  100,  plus  the  effective  interest  rate  for  the  period,  will 
give  the  cost  at  the  beginning  of  the  prior  period. 

Example:  One  hundred  bonds  of  the  M.  K.  T.  Co. 
were  acquired  on  January  i,  1913;  they  are  due  June  30, 
1914,  and  bear  interest  at  5%,  January  and  July.  They 
were  acquired  to  produce  3%.    Required,  cost  of  bonds. 


282      THE    THEORY    OF    THE    ASSET    ACCOUNTS 


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INVESTMENTS 


283 


It  will  be  noticed  that  the  example  shows  the  periods 
in  their  reverse  order. 

Besides  the  methods  suggested  above  for  recording 
the  investment  in  bonds  in  accordance  with  the  very 
purpose  of  the  investment,  there  is  another  which  is 
adopted  by  all  concerns  which  wish  to  make  their  invest- 
ments reflect  market  values.     It  is  as  follows: 

As  to  Principal.  Having  stated  the  investments  at 
cost,  adjust  them  to  the  market  value  at  the  end  of  every 
period,  debiting  or  crediting  the  difference  to  profit  and 
loss.    No  premiums  or  discounts  are  considered. 

As  to  Income.  Take  it  at  the  nominal  rate  of  the 
bonds,  and  make  no  adjustment  whatever. 

It  may  be  said  of  the  foregoing  that  while  this  method 
is  not  objectionable  in  the  case  of  speculative  investments, 
it  should  be  obnoxious  to  the  very  purpose  of  permanent 
investments,  since  they  are  made  for  income,  and  not  for 
speculative  profit. 


The  question  of  discounts  and  premiums  suffered  or 
received  by  corporations  through  the  issue  of  certificates 
of  indebtedness  will  be  taken  up  in  subsequent  chapters. 

4.     Investments  in  Stocks  of  Other  Companies 

Whether  the  reason  for  making  the  investment  has 
been  to  obtain  income,  to  control  competing  interests,  or 
otherwise,  permanent  investments  in  stocks  of  other  com- 
panies should  be  carried  at  cost. 

In  so  far  at  least  as  the  investor  is  concerned,  the 
question  of  discounts  and  premiums  never  arises  in  con- 
nection with  capital  stock.  A  certificate  of  stock  conveys 
no  promise,  expressed  or  implied,  that  a  certain  sum  of 
money  will  be  paid  to  the  holder  at  any  time.  Generally 
speaking,  whatever  is  received  on  account  of  stocks  is 
income,  and  is  commonly  referred  to  as  "dividends  on 


284      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

Stocks."  It  must  be  said,  however,  that  dividends  re- 
ceived on  the  stock  of  mining  companies  which  do  not  set 
aside  a  certain  proportion  of  their  earnings  to  take  care 
of  the  exhaustion  of  ore-bearing  veins  concurrently  with 
operations,  carry  a  certain  return  of  the  original  invest- 
ment. It  is  seldom  possible  to  estimate  what  that  amount 
is,  as  it  is  not  a  positive  and  well-known  quantity,  like  the 
difference  between  par  and  cost  as  in  the  case  of  bonds, 
but  depends  not  only  upon  the  accuracy  of  the  estimate 
of  ore  which  the  veins  will  produce,  but  also  upon  the 
value  of  the  other  assets  of  the  company  when  operations 
cease  because  this  ore  is  exhausted.  Hence,  it  is  very 
difficult  to  set  aside  out  of  dividends,  an  amount  which 
will  truly  offset,  at  the  winding  up  of  the  company,  the 
amount  originally  invested.  The  same  thing  is  true  of 
land  improvement  companies,  and  of  similar  enterprises 
where  the  capital  assets  waste  concurrently  with  the 
progress  of  the  business. 

The  temptation  to  adjust  the  book  value  of  invest- 
ments to  their  market  value  is  admittedly  greater  in 
connection  with  stocks  than  with  bonds,  because  the 
fluctuations  of  stocks  are  greater  and  more  frequent  than  is 
the  case  with  bonds.  Still,  the  principles  which  apply  to 
one  class  of  securities  apply  also  to  the  other.  It  is  quite 
evident  that  before  the  New  York  State  Insurance  De- 
partment restricted  the  investments  in  stocks  which  life 
insurance  companies  were  in  the  habit  of  making,  unfavor- 
able conditions  in  the  securities  market  at  the  end  of  a 
fiscal  period  would  have  had  a  considerable  efTect  upon 
the  dividends  to  policyholders  paid  by  a  company  whose 
custom  it  was  to  adjust  its  investments  periodically  upon 
the  basis  of  market  values.  Assuming  that  at  the  end  of 
the  year  191 2  a  "paper  loss"  of  $20,000,000  had  been 
sustained  owing  to  panicky  conditions,  and  that  one  year 
later  a  "paper  gain"  of  an  equal  amount  had  been  realized, 


INVESTMENTS 


285 


due  to  an  unusually  optimistic  feeling  prevalent  in  Wall 
Street,  the  financial  status  of  the  company  at  December 
31,  1912,  would  not  have  depressed  the  directors  of  the 
company  any  more  than  the  financial  status  at  December 
31,  191 3,  would  have  elated  them.  Their  investments 
being  made  supposedly  with  a  view  to  permanency,  the 
fact  that  the  value  of  their  securities  was  boosted  by 
"bulls"  or  dragged  down  by  "bears"  would  not  have 
affected  them  in  the  least,  for  in  neither  case  was  there 
any  necessity  of  selling  the  investments.  As  a  matter  of 
fact,  however  high  the  value  of  the  securities  might  have 
soared,  the  sudden  appearance  on  the  market  of  a  con- 
siderable block  of  stocks  offered  for  sale  by  life  insurance 
companies  would  very  probably  have  had  the  immediate 
effect  of  lowering  prices. 

But  leaving  aside  the  natural  indifference  of  the  com- 
pany to  "paper  losses"  and  "paper  gains"  on  market 
values,  let  us  consider  the  case  of  two  holders  of  "tontine" 
policies  of  equal  amount,  maturing,  one  at  December  31, 
19 1 2,  and  the  other  at  December  31,  19 13.  It  is  quite 
obvious  that  the  year  191 2  having  sustained  a  supposed 
loss  of  $20,000,000,  the  dividends  received  by  the  holder 
of  the  policy  maturing  in  that  year  would  have  been  dis- 
proportionate to  those  received  in  the  subsequent  year  by 
a  similar  policy  whose  good  fortune  it  was  to  mature  at 
a  time  when  the  "bulls"  were  the  masters  of  the  situation 
in  Wall  Street. 

5.    Investments  in  Real  Estate 

In  connection  with  investments  in  real  estate,  whether 
made  by  direct  purchase,  or  as  a  result  of  the  foreclosure 
of  investments  in  bonds  and  mortgages,  there  arises  the 
question  of  incumbrances. 

Incumbrances  have  been  thus  defined:  "An  interest 
in,  or  chargeable  on,  land,  which  may  subsist  in,  or  in 


286      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

favor  of,  a  third  person,  consistently  with  a  transfer  of 
the  fee,  but  diminishes  the  value  of  the  estate  of  the 
occupant." 

Incumbrances  include:  mortgages  and  the  interest 
thereon  (as  well  as  the  claims  of  the  mortgagee  for  taxes, 
assessments,  and  fire  insurance);  assessments,  taxes, 
mechanics'  liens,  landlords'  liens,  attachments,  judgments, 
visible  easements,  pending  suits,  etc.  Some  of  these  liens, 
to  be  binding  on  third  parties,  must  be  duly  recorded  in 
accordance  with  statutory  provisions,  or  be  otherwise 
known  to  exist;  others  may  be  readily  ascertained 
through  the  exercise  of  proper  diligence  and  care.  In  no 
case  is  the  purchaser  of  incumbered  property  permitted  to 
plead  ignorance.  He  must  examine  records  or  recorded 
liens,  and  must  inquire  in  regard  to  the  existence  of  other 
incumbrances. 

Generally  speaking,  the  purchaser  of  real  property 
takes  only  such  title  as  the  vendor  had.  It  must  be 
added,  however,  that  a  purchaser  is  supposed  to  be  en- 
titled to  a  good  title,  free  of  incumbrances,  and  that,  if 
any  incumbrances  are  existing,  it  is  the  duty  of  the  vendor 
to  remove  them.  Nevertheless,  the  covenants  of  the  deed 
of  sale  will,  in  the  absence  of  fraud  on  the  part  of  the 
vendor,  be  accepted  as  regulating  the  rights  and  the 
liabilities  of  the  parties.  Thus,  if  property  acquired  is 
subject  to  incumbrances,  the  purchaser  either  agrees  to 
take  it  subject  to  these  liens,  which  the  vendor  must 
satisfy,  or  he  specifically  agrees  to  assume  all  liabilities  for 
liens.  In  the  first  instance  he  will  pay  the  value  of  the 
property  as  if  it  were  unincumbered;  in  the  second  in- 
stance he  will  deduct  from  the  purchase  money  the 
amount  necessary  to  liquidate  the  liability  for  existing 
liens. 

In  regard  to  taxes  and  assessments,  the  general  rule 
is  that,  whenever  the  vendor  agrees  to  liquidate,  or  to 


INVESTMENTS 


287 


provide  for,  the  liabilities,  no  lien  whatever  attaches  to 
the  vendee  for  taxes  and  assessments  which  are  liens  at 
the  time  of  the  contract.  As  to  whether  or  not  accrued 
taxes  and  assessments  the  extent  of  which  is  not  positively 
ascertained,  are  liens  at  the  time  of  the  sale,  depends 
largely  upon  the  statutes  of  the  individual  states.  There 
are  some  states,  for  instance,  where  the  law  provides  that 
persons  who  are  the  owners  of  real  property  at  a  certain 
date  of  the  year,  will  be  liable  for  the  taxes  of  that  year. 
In  a  Mississippi  case,  it  was  held  that  where  the  vendor 
agreed  to  liquidate,  or  provide  for,  all  liabilities,  he  was 
liable  for  taxes  fixed  by  statute  as  due  on  a  date  prior  to 
the  contract,  even  though  the  extent  thereof  was  not 
ascertained  for  several  months  thereafter.*  In  the  state 
of  New  York,  it  has  been  held  and  affirmed  that  if  the 
vendor  covenants  to  convey  property  free  of  all  incum- 
brances, taxes,  and  assessments,  the  extent  of  which  is 
determined  in  the  manner  prescribed  by  law  only  after 
the  conveyance,  are  liabilities  of  the  vendee,  and  not  of 
the  vendor,  t 

In  regard  to  all  other  incumbrances,  it  may  be  said 
that  unless  purchasers  of  real  estate  expressly  bind  them- 
selves in  the  deed  of  sale,  they  are  not  liable  to  creditors 
of  the  vendor. 

Accounting  for  Real  Estate  Investments 

So  far  as  accounting  is  concerned,  property  acquired 
subject  to  existing  liens  which  are  not  the  purchaser's 
liability,  is  recorded  by  merely  stating  what  it  cost;  if 
liabilities  are  assumed  by  the  purchaser,  the  property  is 
recorded  at  its  purchase  value,  credit  being  given  to  cash 
for  the  amount  paid,  and  to  the  liabilities  for  the  amount 


•  Vicksburg   Waterworks    Co.    v.    Vicksburgr  Water    Supply   Co.,   80   Miss.   3it 
68,  80. 

t  Lathers  v.  Keog,  109  N.  Y.  583 ;  17  N.  E.  131 ;  affirming  39  Hun  576. 


288      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

assumed  by  the  purchaser  in  taking  over  the  property ;  for 
example : 

1.  Investment  in  Real  Estate.  .$20,000.00 

To  Cash $20,000.00 

For  acquisition  of  a  parcel 
of  property  located  at 
as  de- 
scribed in  a  deed  of  sale, 
reference  to  w  h  i  c  h  is 
hereby  made.  The  prop- 
erty was  subject,  at  the 
time  of  the  transfer  of 
the  fee,  to  a  mortgage  of 
$10,000  which  the  vendor 
has  agreed  to  satisfy  at 
maturity  out  of  the  pro- 
ceeds of  the  sale. 

2.  Investment  in  Real  Estate.  .$20,000.00 

To  Cash $10,000.00 

"  First  Mortgage  Pay- 
able    10,000.00 

For  acquisition  of 

The  property  is  incum- 
bered by  a  first  mortgage 
(describe)  which  has  been 
assumed  by  the  pur- 
chaser. 

Whether  purchased  property  is  incumbered  or  not  at 
the  time  of  acquisition,  the  purchaser  may  incumber  it  by 
giving  to  the  vendor  a  "purchase  money  mortgage" 
covering  part  of  the  purchase  price.  Under  these  con- 
ditions, the  foregoing  illustrations  might  read: 


INVESTMENTS 


289 


1.  Investment  in  Real  Estate.  .$20,000.00 

To  Cash $12,000.00 

"  Purchase  Money 
Mortgage  Pay- 
able    8,000.00 

2.  Investment  in  Real  Estate.  .$20,000.00 

To  Cash $  4,000.00 

"    First      Mortgage 

Payable 10,000.00 

"    Purchase    Money 

Mortgage  Payable  6,000.00 

The  components  of  the  book  value  of  investments  in 
real  estate  may  be: 

1.  The  cost  of  the  property,  including: 

a.  If  the  property  has  been  acquired  in  the  real 

estate  market,  the  cost  of  acquiring  title, 
whatever  the  amount  may  be  in  particular 
cases,  as  well  as  commissions  and  brokerage 
incident  to  the  purchase. 

b.  If  the  property  has  been  acquired  as  a  result 

of  foreclosure,  the  cost  of  all  advances 
made  for  the  account  of  the  mortgagor  by 
the  concern  in  its  capacity  as  mortgagee, 
such  as  amounts  expended  for  taxes,  for 
insurance  premiums,  and  for  repairs  and 
improvements  prior  to  acquisition  of  the 
property  upon  default  of  the  mortgagor. 

2.  The  cost  of  such  improvements  as  enhance  the 

marketable  value  of  the  buildings,  or  make  them 
more  desirable  to  tenants,  or  increase  the  rate 
of  rentals. 

If  the  policy  of  the  concern  is  to  carry  its  investments 
at  market  value,  the  fluctuations  of  the  market  are  re- 


290 


THE  THEORY  OF  THE  ASSET  ACCOUNTS 


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INVESTMENTS  291 

corded  periodically  by  means  of  debits  or  credits  to  the 
asset  account,  and  corresponding  credits  and  debits  to  the 
Profit  and  Loss  account. 

If  the  amounts  involved  are  considerable  and  a  great 
many  separate  parcels  of  property  are  carried,  a  special 
ledger  may  be  assigned  to  the  detail  of  the  asset  account. 
This  book  may  be  made  very  thorough  by  means  of 
sections  which  will  record  the  original  value  and  the 
fluctuations  of  the  investment,  the  original  incumbrances 
attaching  to  the  property,  and  the  gradual  extinguish- 
ment thereof,  and  the  total  of  the  positive  and  negative 
factors  affecting  the  income  received  on  the  investment. 
The  foregoing  form  is  adaptable  to  the  requirements  of 
large  investors. 


CHAPTER   XXIV 

SPECIFIC  FUNDS,  RESERVE  FUNDS,  AND 
FUNDED  RESERVES 

Specific  Funds 

In  the  course  of  business,  it  frequently  becomes  advis- 
able to  set  aside  specific  funds,  in  order  that  certain  pur- 
poses may  be  fulfilled,  or  certain  policies  carried  out. 
Thus,  a  social  club  may  periodically  set  aside  part  of  its 
receipts  for  the  purpose  of  erecting  a  permanent  home  for 
the  association;  a  life  insurance  company  may  set  aside 
and  intrust  to  influential  persons,  funds  which  are  to  be 
used  to  defeat  proposed  legislation  which  it  considers 
fatal  to  principles  of  life  insurance;  a  large  concern  may 
place  considerable  sums  in  the  hands  of  its  officers  to  be 
used  for  the  benefit  of  the  business  at  large  and  accounted 
for  periodically. 

These  specific  funds,  whether  known  as  building, 
emergency,  legislative,  working,  or  experimental  funds, 
or  otherwise,  need  have  no  connection  whatever  with 
profits.  They  are,  in  reality,  part  of  the  available  cash  of 
the  concern,  whether  that  cash  comes  from  operative  re- 
sults or  from  capital  contributions.  Unless  protected  by 
resolutions  of  the  directorate,  they  can  be  used  for  pur- 
poses other  than  that  for  which  they  were  originally  cre- 
ated, and  whenever  the  amount  provided  is  greater  than 
the  requirements,  or  the  policy  which  caused  their  crea- 
tion is  abandoned,  the  balance  reverts  to  the  general  cash. 
They  are  current  assets  and  are  stated  as  such  on  the 
balance  sheet. 

292 


SPECIFIC    FUNDS    AND    RESERVES 


293 


Reserve  Funds 

In  contradistinction,  reserve  funds  are  accumulated 
out  of  realized  profits;  that  is  to  say,  they  are  brought 
into  existence  by  being  separated  from  the  fund  of  liquid 
assets  which  have  come  in  as  a  direct  result  of  profitable 
operations.  They  are  created  for  the  express  purpose  of 
liquidating  liabilities  incurred  in  order  that  the  earning 
power  of  the  concern  may  be  maintained  or  increased,  or 
to  replace  physical  assets  when  they  have  outlived  their 
usefulness.  They  apply  the  principle  of  finance  that  capi- 
tal borrowed  to  obtain  income  should  be  paid  out  of  the 
income  which  it  makes  possible,  or  that  assets  which  have 
been  consumed  by  operations  must  be  replaced  out  of 
profits.  They  can  be  applied  only  to  the  purpose  for 
which  they  were  created,  and  if  they  ever  revert  to  the 
general  cash  it  can  only  be  because  they  were  larger  than 
necessary.  Their  ultimate  disposition  is  so  well  estab- 
lished that  they  cannot  be  considered  as  current,  or  liquid 
assets;  the  Interstate  Commerce  Commission  includes 
them  among  deferred  debit  items,  that  is  to  say,  it  treats 
them  as  factors  which  can  only  fulfil  their  mission  by  be- 
ing debited  to  the  particular  liability  which  they  are  in- 
tended to  extinguish,  or  to  the  particular  asset  the  value 
of  which  they  will  eventually  measure. 

Funded  Reserves 

If  corporations  borrow  capital  in  order  that  they  may 
obtain  therewith  an  income  greater  than  the  cost  of  bor- 
rowing, and  if  prudence  requires  that  part  of  the  excess 
income  thus  obtained  be  applied  to  the  liquidation  of  the 
debt,  there  are  two  distinct  ways  of  arriving  at  the  re- 
quired result : 

I.  Set  aside  periodically  a  proportion  of  the  profits 
which  have  been  realized,  in  cash,  thereby  cre- 
ating reserve  funds.    As  indicated  above,  this  is 


294      ^^^    THEORY    OF    THE    ASSET    ACCOUNTS 

done  by  crediting  cash,  and  debiting  a  fund  so 
earmarked  as  to  indicate  the  purpose  of  the 
special  deposit;  the  cash  reserved  is  usually  in- 
vested in  some  manner  deemed  suitable  or  ad- 
vantageous, i.e.,  it  may  be  left  in  a  deposit  account 
with  a  bank,  or  it  may  be  exchanged  for  interest- 
bearing  securities. 

2.  Set  aside  periodically  a  proportion  of  the  net 
profits,  by  debiting  "Profit  and  Loss" — the 
summary  account  which  measures  them — or 
"Surplus" — the  other  summary  account  which 
contains  them — and  crediting  properly  ear- 
marked "reserves"  which  will  measure  the 
aggregate  amount  of  surplus  appropriated  for 
special  purposes. 

It  will  be  noticed  that  either  method  accomplishes  its 
purpose  properly;  the  reserve  prevents  the  distribution  of 
the  reserved  cash  profits  otherwise  than  for  the  liquida- 
tion of  certain  obligations;  the  fund  is  just  as  effective, 
since  it  sets  aside  and  earmarks  as  reserved  for  special 
purposes,  part  of  the  cash  obtained  through  profits. 

If  a  reserve  has  been  created,  and,  in  addition  to  this, 
cash  is  set  aside  in  a  special  fund,  it  is  only  because  of 
scrupulous  conservatism.  This  operation,  which  is  re- 
ferred to  as  "funding  reserves,"  has  been  criticized  as 
often  as  the  wisdom  of  creating  reserve  funds  has  been 
challenged.  Railroad  economists  claim  that  to  invest  the 
large  amounts  necessary  to  liquidate  the  bonded  indebted- 
ness of  common  carriers,  at  a  rate  of  interest  infinitely 
inferior  to  the  earnings  which  that  money  could  secure  if 
used  for  the  requirements  of  the  road,  is  equivalent  to  mis- 
management. They  further  assert  that  the  greatest 
security  which  railroad  bondholders  can  have  is  the  pros- 
perity of  the  enterprise,  and  that  anything  that  detracts 


SPECIFIC    FUNDS    AND    RESERVES  295 

from  that  prosperity  is  detrimental  to  their  interests:  that 
since  reserve  funds,  by  withdrawing  cash  from  operation, 
reduce  the  income  of  railroads,  they  should  not  be 
created,  the  reserve  alone  being  sufficient. 

It  sometimes  happens,  however,  that  bond  indentures 
compel  the  periodical  payment  to  a  trustee  of  certain 
sums  which  will  accumulate  at  interest  until  sufficient  to 
liquidate  certain  debts.  When  this  is  the  case,  nothing 
but  the  reserve  fund  will  satisfy  the  bondholders,  and  the 
usefulness  of  a  reserve  carried  in  conjunction  with  the 
fund  is  more  than  problematic. 

The  meaning  of  the  term  "reserve  fund"  as  given  in 
the  foregoing,  is  far  from  being  generally  accepted. 
Many  writers  of  accounting  hold  that  there  is  no  differ- 
ence whatever  between  "reserve  funds"  and  "reserves," 
and  that  both  are  amounts  set  aside  out  of  profits,  to  be 
used,  if  the  occasion  requires,  to  write  down  the  book 
value  of  the  assets  to  which  they  apply. 

It  is  true,  of  course,  that  a  reserve  for  depreciation  of 
machinery  will  be  applied  to  the  undepreciated  book 
value  of  the  assets  when  the  machinery  has  outlived  its 
usefulness;  but  that  reserve  is  not  a  fund,  although  it 
could  be  funded.  It  is  also  evident  that  a  reserve  for 
redemption  of  bonded  indebtedness  could  never  be  ap- 
plied to  the  reduction  of  any  asset  whatever,  and  that  it 
is  not  a  fund  at  all,  although  it  is  supposed  to  be  repre- 
sented by  funds  which  are  not  specifically  invested.  The 
Interstate  Commerce  Commission  appears  to  have  settled 
the  controversy;  it  requires  that  reserves  created  out  of 
income  or  surplus  be  shown  as  follows,  on  the  balance 
sheet  of  common  carriers: 

1.  Invested  in  Sinking  and  Redemption  Funds 

2.  Invested  in  Other  Reserve  Funds 

3.  Not  Specifically  Invested 


296 


THE  THEORY  OF  THE  ASSET  ACCOUNTS 


Sinking  Funds 

The  most  common  of  all  the  "reserve  funds"  is  the 
"sinking  fund  for  the  redemption  of  bonds."  These  sink- 
ing funds  may  be  created  in  several  ways: 

1.  Taking  as  a  basis  the  life  of  the  debt  to  be  liqui- 

dated, deposit  periodically  amounts  equivalent 
to  1/5,  or  i/io,  or  1/20  of  the  original  amount 
due,  less  whatever  interest  the  fund  as  it  stands 
has  earned  during  the  prior  period,  it  being 
understood  that  the  last  deposit  produces  no 
interest. 

2.  Divide  the  amount  of  the  debt  to  be  liquidated,  by 

the  amount  of  the  annuity  of  $1  for  the  given 
term  of  the  debt,  at  a  given  rate.  The  quo- 
tient will  be  the  amount  of  dollars  of  each  suc- 
cessive sinking  fund  instalment. 

The  examples  A  and  B  show  that  the  interest  earned 
by  the  sinking  fund  is  debited  to  the  fund  itself,  and 
credited  to  the  earning  account  "Interest  on  Sinking 
Fund."  It  has  been  claimed  that  it  should  be  credited 
to  the  account  which  is  debited  with  the  interest  paid  on 
the  bonds.  The  intrinsic  worth  of  such  a  theory  is  to  be 
appraised  in  the  light  of  principles  of  finance.  The  in- 
terest earned  by  a  fund  created  by  setting  aside  assets 
obtained  out  of  the  reinvestment  of  profits  made  possible 
by  the  incurrence  of  long-term  liabilities,  is  hardly  a  de- 
duction from  the  cost  of  carrying  that  liability. 

So  far  as  their  accounting  treatment  is  concerned,  re- 
demption funds  are  similar  in  every  respect  to  sinking 
funds.  The  difference  in  terminology  merely  means  that 
sinking  funds  are  supposed  to  be  created  in  compliance 
with  what  is  known  as  the  "sinking  fund  provision"  of 
bond  indentures,  whereas  redemption  funds  are  created 
to  retire  any  long-term  liability  which  is  not  subject  to 
sinking  fund  requirements. 


SPECIFIC    FUNDS    AND    RESERVES 


297 


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THE    THEORY    OF    THE    ASSET    ACCOUNTS 


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CHAPTER  XXV 

ACCRUED    INCOME   NOT   DUE 

Income  from  Investments 

The  income  from:  (i)  investments  in  real  estate,  (2) 
bonds  of  other  companies,  loans  on  collateral  (call  or 
time),  bonds  and  mortgages,  and  (3)  stocks  of  other 
companies,  is,  in  the  order  given:  rent,  interest,  and 
dividends. 

Since  the  date  at  which  rents  and  interest  mature 
does  not  always  coincide  with  the  last  day  of  the  ac- 
counting period,  it  follows  that  an  amount  of  income  on 
investments  may  have  been  earned  which  does  not 
appear  on  the  books,  because  cash  has  not  been  received 
therefor. 

The  Cash  Basis 

It  may  be  that  the  policy  of  a  concern  is  to  keep  its 
books  on  the  "cash  basis,"  that  is  to  say,  to  consider  as 
income  earned  only  that  which  has  been  received  in  cash, 
and  that,  correspondingly,  only  expenses  paid  in  cash  con- 
stitute income  disbursed.  This  policy  has  the  great 
disadvantage  of  not  being  consistent.  It  rests  upon  the 
possibility  that  the  right  to  receive  income  may  be  lost 
by  the  failure  of  the  debtor  to  pay  what  he  owes,  and 
upon  the  impossibility  of  enforcing  payment  when  such 
contingency  occurs.  But  if  the  basis  is  correct,  it  should 
apply  also  to  accounts  receivable  recorded  as  a  result  of 

299 


300      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

sales  on  credit,  since  the  amount  charged  to  customers 
contains  not  only  the  cost  of  the  goods  sold  to  them,  but, 
as  well,  the  profit  realized  on  the  sales.  It  is  obvious  that 
if  it  is  sound  theory  to  ignore  income  until  it  is  received, 
it  is  also  sound  theory  to  ignore  the  profit  on  sales  until 
the  customers  have  paid  the  indebtedness  which  contains 
those  profits.  Yet  it  is  doubtful  whether  a  single  instance 
could  be  found  where  a  business  concern  which  claims  to 
be  on  a  cash  basis  is  consistent  enough  to  apply  that 
basis  to  merchandise  transactions. 

The  Accrual  Basis 

Many  concerns  keep  their  books  on  the  "accrual 
basis."  This  method  applies  the  accounting  principle  that 
the  primary  connection  between  the  net  assets  and  the 
net  income  derived  therefrom,  is  a  matter  of  earnings  and 
of  expense  incurred,  and  not  one  of  income  received  in 
cash  and  expenses  paid  in  cash.  It  takes  cognizance  of 
the  fact  that  unless  income  is  recorded  when  earned, 
losses  due  to  the  failure  to  collect  that  income  cannot 
appear  on  financial  statements. 

It  might  be  supposed  that  an  accountant  had  earned, 
during  a  calendar  year,  say,  $10,000,  and  had  been  un- 
able to  collect  more  than  half  of  that  sum,  the  balance 
being  bad  debts.  If  his  books  were  kept  strictly  on  the 
cash  basis  his  earning  capacity  would  be  shown  to  have 
been  $5,000  during  that  year,  and  no  loss  would  appear 
in  his  income  account.  If  his  books  were  kept  on  the 
accrual  basis,  that  capacity  would  be  shown  to  have  been 
$10,000,  and  his  financial  statements  would  show  the  fact 
that,  being  unable  to  collect  more  than  half  of  that  sum, 
he  had  sustained  a  loss  of  $5,000,  owing  to  the  financial 
incapacity  of  his  clients  or  their  bad  faith. 

Leaving  expenses  and  liabilities  out  of  the  question 
for  the  time  being,  the  adoption  of  the  accrual  basis 


ACCRUED    INCOME    NOT    DUE  '  301 

meflns  that  at  the  end  of  every  accounting  period,  all  in- 
come which  has  been  earned  during  that  period  must  be 
recorded  as  an  accrued  asset  which,  while  perhaps  not 
collected  at  the  time,  because  it  is  not  due,  may  be  col- 
lected at  some  future  time.  This,  of  course,  necessitates 
the  recording  of  an  income  which  will  be  credited  to  the 
profit  and  loss  of  the  period,  whether  or  not  the  accrued 
asset  which  it  represents  fails  of  collection.  Thus,  if  the 
last  interest  receivable  on  investments  in  bonds  of  other 
companies  or  in  bonds  and  mortgages  or  in  loans  on 
collateral,  was  received  December  i,  and  the  accounting 
period  ends  December  31,  there  has  been  earned  interest 
for  one  month,  which  is  an  asset  of  the  investor  as  well  as 
it  is  his  income  for  the  month  of  December. 

Nature  of  Dividends 

Dividends  diflfer  materially  from  rentals  and  interest; 
they  do  not  belong  to  the  stockholders  until  they  have 
been  declared  and  the  knowledge  of  the  resolution  of 
the  board  of  directors  has  become  known  outside  of  the 
board  room.  Hence,  it  is  not  possible  to  take  as  an 
asset  and  as  income,  dividends  which  are  expected  on 
investments  in  stocks  of  other  companies,  since  there  is 
no  certainty  that  the  directors  will  deem  it  advisable  to 
distribute  part  of  the  surplus.  But  if  a  dividend  has  been 
declared,  its  amount  must  be  taken  both  as  an  asset  and 
as  income,  even  though  it  be  made  payable  months  later. 
The  legitimacy  of  the  asset  cannot  be  denied,  since,  after  a 
dividend  has  been  declared,  it  cannot  be  rescinded  unless  it 
has  been  established  that  its  declaration  was  illegal. 

Record  of  Earnings  on  Investments 

The  journal  entries  giving  expression  to  the  earnings 
on  investments  and  to  the  corresponding  accrued  assets 
which  they  represent,  are  as  follows: 


302      THE    THEORY    OF    THE    ASSET    ACCOUNTS 


Accrued  Rentals— Real  Estate.. $, 
Accrued  Interest  on  Bonds  of 

Other  Companies 

Accrued    Interest    on    Bonds 

and   Mortgages 

Accrued  Interest  on  Collateral 

Loans  

Dividends  Receivable  (de- 
clared)     

To  Rentals  on  Real  Es- 
tate   

"    Interest  on  Bonds  of 
Other  Companies 
"    Interest    on    Bonds 
and  Mortgages . . 
"    Interest   on   Collat- 
eral Loans 

"  Dividends  on  Stocks 
o  f  Other  Com- 
panies  

To  set  up  both  the  asset 
and  the  income  derived 
from  investments. 


Whatever  is  collected  on  the  asset  should  be  credited 
to  the  asset  account,  in  order  that  it  may  show  at  any 
time  the  balance  accrued  thereunder,  and  not  as  yet  col- 
lected or  collectable.  The  income  account  should  contain 
no  credits  whatever  on  account  of  cash  receipts,  and  the 
debit  side  of  the  accrued  asset  should  at  all  times  be 
equal  to  the  credit  side  of.  the  earning  account.  This 
means  that  if  an  investment  is  sold  or  expires  during  an 
accounting  period,  the  first  care  of  the  accountant  should 
be  to  make  both  the  asset  account  "Accrued  Interest" 
and  the  income  account  "Interest"  reflect,  in  anticipation, 


ACCRUED    INCOME    NOT    DLE 


303 


that  part  of  the  proceeds  of  the  sale  or  of  the  settlement 
at  maturity,  which  will  not  represent  principal.  Unless 
this  is  done,  the  books  will  show  that  interest  income  was 
obtained  partially  through  the  accrual  of  an  asset  and 
partially  through  the  receipt  of  cash. 

To  illustrate:  On  January  15,  1914,  A  loaned  B, 
against  proper  collateral,  $10,000,  at  6%,  principal  re- 
payable on  July  15,  1914,  interest  payable  at  maturity. 
A  closes  his  books  on  the  last  day  of  every  month. 

At  July  15,  1 9 14,  prior  to  the  settlement  made  by  B, 
A's  books  show,  on  the  360-day  basis: 

Investment  in  Loans  on  Collateral 


1914 

Jan.  15    Cash $10,000.00 

Accrued  Interest  on  Loans  on  Collateral 


I9I4 

Jan.  30 

Interest  on  Loans 
on  Collateral.. 

$  25.00 

Feb.  28 

50.00 

Mar.  31 
Apr.  30 
May  31 
June  30 

•• 

50.00 
50.00 
50.00 
So.oo 

$275.00 

Interest 

on  Loans  on  Collateral 

1914 

1914 

Jan.  30 

Profit  & 

Loss. 

.  $  25.00 

Jan.  30 

Accrued   Interest 

Feb.  28 

(( 

50.00 

on    Loans    on 

Mar.  31 

« 

.     50.00 

Collateral  $  25.00 

Apr.  30 

<( 

.     50.00 

Feb.  28 

....      50.00 

May  31 

« 

.     50.00 

Mar.  31 

....      SO.00 

June  30 

u 

.     50.00 

Apr.  30 
May  31 
June  30 

....      50.00 
....      50.00 
....      50.00 

$275.00 

$275.00 

1 

304      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

Now,  if  upon  settlement  by  B,  on  July  15,  1914,  A 
makes  the  following  entry: 

Cash $10,300.00 

To  Investments  in 
Loans  on  Collat- 
eral   $10,000.00 

"  Accrued  Interest  on 
Loans  on  Collat- 
eral     275.00 

"    Interest    on    Loans 

on  Collateral ....  25.00 

it  is  evident  that  the  asset  account  "Accrued  Interest" 
will  fail  to  reflect  the  whole  amount  of  the  earnings  to 
which  it  owes  its  existence,  and  that  the  earning  account 
will  be  composed  of  two  distinct  elements: 

1.  One,  said  to  be  an  earning,  due  to  the  fact  that  an 

asset  receivable  was  placed  on  the  books. 

2.  The  other,  said  to  be  income,  due  to  the  fact  that 

cash  came  in,  in  settlement  of  interest  earned. 

Would  it  not  be  more  logical  to  carry  the  theory  of  ac- 
cruals throughout  the  accounting  period,  and  on  the  day  of 
settlement  of  the  loan  make  the  following  journal  entries? 

I.  Accrued  Interest  on  Loans 

on  Collateral $        25.00 

To  Interest  on  Loans 

on  Collateral $       25.00 

For  interest  accrued  to 
date  of  settlement  of 
principal  and  of  inter- 
est on  loan  of  $10,000 
secured  by  collateral, 
maturing  this  day. 


ACCRUED    INCOME    NOT    DUE  oqc 

2.  Cash $10,300.00 

To  Loans  on  Collat- 
eral   10,000.00 

"    Accrued    Interest 
on   Loans    on 

Collateral  , .  .  300.00 

For  settlement  of  loan 
and  collection  of  assets 
receivable  on  account 
of  interest  from  Janu- 
ary i,  1914,  to  July  15, 
1914. 

Income  from  Bonds 

If  reference  is  made  to  the  discussion  of  investment  in 
bonds  of  other  companies,*  it  will  be  found  that  the 
nominal  account  representing  the  income  derived  there- 
from, may  under  certain  conditions  contain  debits  and 
credits  for  amortization  and  accumulation  of  cost  of  in- 
vestments to  par.  It  must  be  said  at  this  point,  that  even 
where  investments  are  carried  at  par,  and  separate 
accounts  are  kept  for  discounts  and  premiums,  the  nature 
of  these  latter  accounts  is  such  that  they  should  be  written 
down  by  means  of  periodical  credits  and  debits  to  the 
nominal  account  representing  interest  on  investments  in 
bonds,  and  not,  as  is  so  often  the  custom,  by  credits  and 
debits  to  the  Profit  and  Loss  account. 

When  the  conditions  just  described  prevail,  the  asset 
account  "Accrued  Interest  on  Investments"  should  con- 
tain the  nominal  rate  receivable  on  the  face  of  the  bonds, 
since  in  case  of  default  the  amount  claimed  by  the  in- 
vestor will  be  the  principal,  i.e.,  par,  plus  the  interest  on 
par  at  the  rate  stated  on  the  instrument  of  credit.  As  to 
the   earning   account,    it   should   reflect   the  true   income 

•  Chapter  XXIII. 


3o6 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


which  the  bonds  were  to  produce  at  the  price  at  which 
they  were  acquired.  This  is  the  only  case  where  the  debit 
side  of  the  asset  account  "Accrued  Interest  on  Invest- 
ments" should  not  duplicate  exactly,  and,  at  all  times,  the 
credit  side  of  the  earning  account  "Interest  on  Invest- 
ments." 


CHAPTER  XXVI 

ACCOUNTS  PARTIALLY  REAL  AND  PARTIALLY 
NOMINAL— DEFERRED  DEBIT  ITEMS 

Allocation  of  Periodical  Expenses 

When  a  concern  has  adopted  the  policy  of  charging 
against  the  income  of  a  period,  all  the  expenditures  made 
and  all  the  obligations  incurred  during  that  period  for  the 
protection  of  the  physical  assets,  as  well  as  for  the  acqui- 
sition of  minor  supplies  intended  to  be  consumed  through 
the  operation  of  the  business  as  a  whole,  the  question  of 
accounts  partially  real  and  partially  nominal  arises  only 
in  connection  with  trading  or  manufacturing  goods.* 

The  policy  referred  to  above  is  often  qualified  as 
"conservative"  by  those  who  have  adopted  it.  Usually, 
however,  it  is  objectionable  to  accountants  because,  by 
making  the  profits  of  certain  periods  sufTer  a  detriment 
for  the  benefit  of  other  periods,  it  destroys  utterly  the 
value  of  comparisons. 

When  profits  are  ascertained  yearly,  it  may  be  said 
with  a  semblance  of  truth  that  the  law  of  averages  is  likely 
to  make  all  periods  very  nearly  alike,  since  the  same  ex- 
penses are  bound  to  occur  year  in  and  year  out,  unless 
changes  of  policy  have  taken  place  in  the  interim.  Still, 
this  is  not  always  true.  Let  us  assume,  for  instance,  that 
on  January  2,  191 2,  a  building  was  insured  against  fire, 
the  policy  covering  a  period  of  three  years;  it  is  obvious 
that  because  the  year  191 2  has  been  made  to  bear  the 


Discussed  in  Chapter  XVI. 


3o8      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

burden  of  the  whole  insurance  premium  paid  during  that 
year,  the  profits  will  suffer  by  comparison  with  the  future 
profits  of  the  years  1913  and  1914.  And,  if  in  the  year 
191 3  a  large  amount  of  stationery  is  acquired  in  order  to 
take  advantage  of  the  considerable  saving  which  large 
orders  afford  when  type  has  to  be  set  up,  it  is  evident  that 
unless  the  cost  of  these  supplies  is  spread  over  the  periods 
in  which  they  are  consumed,  the  year  191 3  will  sustain  a 
burden  which  the  law  of  averages  will  not  relieve  in  the 
least. 

It  is  for  this  reason  that  accountants  recommend 
that,  at  the  end  of  every  accounting  period,  a  sharp  line 
be  drawn  between  the  expenses  applicable  to  the  period 
which  has  just  expired,  and  the  expenses  applicable  to 
subsequent  periods. 

Common  Accounts  Partially  Real  and  Partially  Nominal 

The  individual  accounts  which  may  be  considered  as 
partially  real  and  partially  nominal,  vary  according  to  the 
particularities  of  business.    The  most  commonly  found  are : 

1.  Fire  Insurance  Premiums 

2.  Advertising  Contracts 

3.  Stable  Supplies 

4.  Stationery  and  Printing 

5.  Advertising  Matter 

These  accounts  are  subject  to  periodical  inventories. 
This  statement  applies  even  to  fire  insurance  premiums, 
since,  to  ascertain  the  amount  applicable  to  subsequent 
periods,  it  is  necessary  to  marshal  the  policies,  and  con- 
sider their  terms.  It  is  precisely  because  the  values  which 
they  represent  are  susceptible  of  being  inventoried,  that 
they  are  to  be  found  stated  under  the  balance  sheet  group 
"Working  and  Trading  Assets,"  together  with  the  in- 
ventories of  trading  goods,  manufacturing  materials, 
goods  in  process,  and  finished  goods. 


DEFERRED    DEBIT    ITEMS  309 

Fire  Insurance  Premiums 

The  advisability  of  carrying  as  an  asset  the  portion 
of  the  fire  insurance  premiums  which  applies  to  periods 
subsequent  to  the  one  at  issue,  results  not  only  from  the 
requirements  of  proper  accounting,  but,  as  well,  from  the 
very  nature  of  the  contract  of  insurance  for  which  the 
premium  paid  is  the  consideration. 

The  law  provides  that  whenever  an  insured  party  sur- 
renders his  policy,  orders  it  canceled,  and  demands  the 
refund  of  the  unconsumed  proportion  of  premium  paid 
thereunder,  his  right  to  the  refund  shall  be  absolute,  pro- 
vided the  policy  contract  contemplates  the  eventuality  of 
cancellation.  The  amount  of  premium  to  be  refunded  will 
not,  however,  be  the  proportion  of  the  whole  which 
applies  to  the  unexpired  period  covered  by  the  original 
contract.  It  will  be  the  amount  of  the  premium,  less  what 
the  cost  of  insurance  would  have  been  if  the  policy  had 
been  issued  for  the  time  during  which  the  insurer  was  in 
the  risk.*  The  insurer  may,  besides,  deduct  from  the 
amount  of  the  premium  to  be  returned,  his  "reasonable" 
expenses  in  writing  the  policy. 

Hence,  the  amount  of  fire  insurance  premiums  which 
going  concerns  carry  as  an  asset  at  the  end  of  an  account- 
ing period,  is  never  the  exact  amount  which  would  be 
received  if  the  policy  were  to  be  canceled  on  what  is 
called  the  "short  rate"  basis.  Still,  for  the  purpose  of 
statements  purporting  to  show  the  financial  status  of  such 
concerns,  it  is  evident  that  the  only  expense  incurred  on 
account  of  fire  protection,  is  the  proportion  of  it  which 
applies  to  the  period  covered  by  the  statement,  since 
there  is  no  intention  of  surrendering  the  policy. 

For  the  purposes  of  statements  purporting  to  exhibit  the 
financial  status  of  a  concern  facing  liquidation  through 
financial  distress  or  otherwise,  it  is  better  to  carry  the  asset 


*  Matter  of  Indepeadence  Insurance  Co.,  13  Fed.  Cas.  No.  7015. 


^lO   THE  THEORY  OF  THE  ASSET  ACCOUNTS 

"Fire  Insurance  Premiums,  Unexpired  Proportion,"  at  the 
probable  value  to  be  received  upon  cancellation  of  the 
policy.  What  that  value  will  be,  is  indicated  by  what  is 
known  as  "Union  Short  Rate  Tables." 


Advertising  Contracts 

When  advertising  contracts  have  been  paid  in  ad- 
vance, it  is  customary  to  apportion  their  cost  over  the 
periods  during  which  they  run.  The  word  "paid"  does 
not  necessarily  mean  paid  in  cash.  If  a  going  concern  has 
placed  an  advertising  contract  for  a  year,  agreed  to  pay 
monthly  a  sum  of  $ioo  therefor,  and  recorded  its  rights 
and  duties  under  the  contract  in  the  following  manner; 

Advertising  Contract $1,200.00 

To  Creditor's  Account. . .  $1,200.00 

it  has,  so  far  as  accounting  is  concerned,  paid  $1,200  in 
advance,  since  it  has  recorded  a  lien  of  that  amount 
against  the  assets  held.  Hence,  unless  it  treats  the  un- 
consumed  portion  of  the  consideration  for  the  liability 
as  an  asset,  it  will  not  state  its  true  financial  status. 

What  the  value  of  an  unexpired  advertising  contract 
is  to  a  concern  about  to  liquidate,  depends  naturally  upon 
the  terms  of  the  contract  itself.  If  it  has  been  paid  for 
in  cash  in  advance  of  the  performance  by  the  advertising 
concern,  a  compromise  agreement  may  be  reached 
whereby  the  client  will  receive  back  a  portion  of  his  pay- 
ments, in  consideration  of  the  cancellation  of  the  contract. 
The  recording  of  such  a  transaction  would  consist  in 
debiting  cash  with  the  amount  received,  debiting  profit 
and  loss  with  the  loss  (if  any)  represented  by  the  excess 
paid  in  advance,  under  the  contract,  over  the  amount  re- 
turned, and  crediting  the  asset  account  "Advertising 
Contracts,  Unexpired  Portion." 


DEFERRED  DEBIT  ITEMS  311 

If  the  business  concern  makes  monthly  payments,  but 
has  recorded  the  whole  contract  as  suggested  in  the  fore- 
going entry,  and,  upon  a  plea  of  impossibility  to  perform, 
has  obtained  a  cancellation  of  the  contract,  the  only  ac- 
counting necessary  will  be  to  debit  the  liabiHty  account 
reflecting  the  amount  still  due  under  the  contract,  and  to 
credit  the  asset  account  supposed  to  represent  the  right 
of  the  concern  under  the  contract  now  canceled.  This, 
of  course,  is  true  only  if  the  two  amounts  are  equal. 

If  the  contract  is  assignable,  that  is  to  say,  if  no  pro- 
vision thereof  opposes  its  being  assigned,  and  if  there  is 
no  liability  to  be  incurred  thereunder  by  the  assignee,  the 
concern  assigning  its  rights  will  merely  debit  cash  with 
the  amount  of  the  consideration  received  from  the 
assignee.  Any  difference  between  the  book  value  of  the 
contract  and  the  consideration  for  its  assignment  will 
be  debited  or  credited  (as  the  case  may  be)  to  profit  and 
loss. 

Stable  Supplies,  Stationery  and  Printing,  Advertising 
Matter 

The  individual  inventorial  value  of  these  assets  may 
or  may  not  be  deemed  important  enough  to  be  included 
in  the  balance  sheet;  still,  the  amount  of  an  account 
should  have  no  bearing  whatever  upon  its  treatment  at 
the  end  of  a  period.  Unless  this  principle  is  carefully 
applied  at  all  times,  the  cost  of  operations  of  any  given 
period  may  be  incorrectly  stated,  to  say  nothing  of  the 
financial  status  of  the  concern. 

Stable  supplies  are  obviously  a  valuable  asset  of  a 
going  concern  as  well  as  of  a  concern  about  to  liquidate. 
In  the  latter  case,  they  are  subject  to  market  fluctuations, 
and  to  the  hazards  of  an  auction  sale;  but  they  are  at  all 
events  a  legitimate  asset. 

The  value  of  stationery  and  printing  is  so  problematic 


312      THE    THEORY    OF    THE    ASSET    ACCOUNTS 

to  a  going  concern  that  the  Insurance  Department  of  the 
State  of  New  York  does  not  permit  of  its  being  shown  in 
the  balance  sheet  of  insurance  companies;  the  application 
of  the  unexpired  portion  of  the  account  to  any  given 
period,  involves  the  consideration  of  the  proper  time 
to  charge  to  expense,  books  of  account,  records,  and 
memoranda,  which  may  outlive  considerably  the  period  in 
which  they  are  put  in  use;  furthermore,  the  question  of 
obsolescence  of  type  is  forever  present  in  the  consideration 
of  the  inventorial  value  of  the  asset.  As  to  concerns  about 
to  Hquidate,  the  value  of  the  asset  to  them  is,  of  necessity, 
its  scrap  price. 

The  value  of  advertising  material  remaining  on  hand 
at  the  end  of  a  period,  from  the  point  of  view  of  a  going 
concern,  is  its  cost.  This,  of  course,  is  true  only  provided 
the  advertising  policy  of  the  concern  has  undergone  no 
radical  change  during  the  period.  In  the  contrary  case, 
the  cost  of  the  now  obsolete  material  must  be  charged  to 
profit  and  loss.  To  a  concern  about  to  liquidate,  advertis- 
ing material  is  mere  scrap. 

Clearing  Partially  Real  and  Partially  Nominal  Accounts 

Accounts  partially  real  and  partially  nominal  must  be 
relieved  periodically  of  their  nominal  portion,  or  of  their 
real  portion.  In  the  first  instance,  they  are  considered  as 
inventory  accounts,  the  consumed  portion  of  which  is  to 
be  charged  to  profit  and  loss;  in  the  second  instance,  they 
are  considered  as  nominal  accounts,  which  may  or  may 
not  be  entirely  consumed  for  the  purpose  intended.  If 
not  entirely  consumed,  the  real  portion  must  be  carried 
forward  as  an  asset.  In  either  case,  the  treatment  is  the 
same.  It  is  not,  however,  necessary  to  wait  until  in- 
ventory time  to  determine  the  nominal  portion  of  these 
accounts.  If  treated  as  inventory  accounts  they  may  be 
credited  whenever  part  of  the  material  which  they  contain  is 


DEFERRED    DEBIT    ITEMS 


313 


issued  to  the  stable,  or  to  the  different  departments  and 
offices  of  the  organization  as  a  whole. 

First  Method 

The  Stable  Supplies  account  of  a  concern  opens  on 
January  i,  1914,  with  an  inventory  of  $150;  during  the 
subsequent  accounting  period,  there  is  purchased  on 
credit,  $500  worth  of  supplies.  At  the  end  of  the  period 
the  inventory  shows  an  asset  of  $75.  The  accounts 
affected  by  the  transaction  stated  would  show: 

Stable  Supplies 

Account  considered  as  inventory  account  or  as  a  nominal  account 
with  a  possible  residual  value. 


1914 
Jan.     I     Stable  Supplies 

(Old  Account). $150.00 
June  30    Creditors 500.00 


$650.00 


July    I     Stable  Supplies 

(Old  Account) .  $75-00 


1914 
June  30    Profit  and  Loss.  .$575.00 
Stable  Supplies 
(New  Account) .  75.00 


$650.00 


Profit  and  Loss 


1914 

June  30    Stable  Supplies... $575.00 


Second  Method 

The  Stationery  and  Printing  account  of  a  concern 
opens  January  2,  19 14,  with  an  inventory  of  $300;  during 
the  period  there  is  purchased  on  credit  $250.  In  Febru- 
ary, $175  worth  of  material  was  issued  to  the  adminis- 
trative department;  in  March,  $50  worth  was  issued  to 
the  factory  office.    In  May,  $80  worth  was  issued  to  the 


314 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


selling  department.  At  the  end  of  the  period  the  status  of 
the  accounts  affected  by  the  above  transactions  is  as 
follows: 

Stationery  and  Printing 


I9I4 

1914 

Jan.    2 

Balance   .... 

$300.00 

Feb.  28 

Stationery      and 

June  30 

Creditors  . . . . 

250.00 

Mar.  31 
May  30 

Printing  E  x  - 
pended  —  Ad- 
ministration  .  .$175.00 

Stationery  and 
Printing  E  x  - 
pended  —  Fac- 
tory Office  ...     50.00 

Stationery  and 
Printing  E  x  - 
pended  —  Sell- 
ing       80.00 

Balance  — 

June  30 

Balance 245.00 

$550.00 
$245.00 

$550.00 

July    I 

Stationery  and  Printing  Expended — Administration 


1914 

June  30    Stationery      and 

Printing $i7S.oo 


Stationery  and  Printing  Expended — Factory  Office 


1914 

June  30    Stationery      and 

Printing $50.00 


Stationery  and  Printing  Expended— Selling 


1914 

June  30    Stationery      and 

Printing $80.00 


DEFERRED  DEBIT  ITEMS  315 

Deferred  Debit  Items 

The  expenses  and  losses  incurred  and  sustained  during 
a  given  period,  may  not  apply  to  that  particular  period; 
if,  for  instance,  an  accounting  period  comes  to  a  close  on 
June  30,  and  during  that  month  there  has  been  paid  $150 
for  rent  of  June  and  July,  it  is  obvious  that  the  applica- 
tion of  $75  to  the  rent  expense  must  be  deferred  until  the 
subsequent  period.  Similarly,  if  a  note  maturing  three 
months  from  June  15  has  been  discounted  on  that  day, 
the  loss  of  the  discount  cannot  be  made  to  fall  upon  the 
month  of  June,  but  must  be  spread  over  the  three  months 
ending  September  15. 

The  items  which  may  be  properly  included  among  the 
deferred  debits,  are  not  assets  in  the  strict  sense  of  the 
word,  since  the  question  of  their  availability  never  arises. 
So  far  as  the  average  business  is  concerned,  they  represent 
expenses  which  have  no  residual  value  other  than  the 
benefits  for  which  they  have  paid  but  which  will  be  en- 
joyed only  in  subsequent  periods,  or  losses  which  respect 
for  the  accounting  truth  requires  to  be  apportioned  to  the 
periods  to  which  they  legitimately  belong. 

The  Interstate  Commerce  Commission  has  greatly 
extended  the  generally  accepted  meaning  of  the  word 
"deferred"  when  applied  to  accounts;  and  this  will  be  re- 
ferred to  again  when  speaking  of  the  effect  of  the  com- 
mission's rulings  upon  accounting  theories  and  methods. 

Generally  speaking,  deferred  debit  items  include: 

1.  Rent  paid  in  advance 

2.  Taxes  paid  in  advance 

3.  Interest   and   discount,   proportion  applicable  to 

subsequent  periods 

4.  Premiums  paid  on  investments 

5.  Discounts  suffered  on  issues  of  long-term  obliga- 

tions 


3i6 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


The  treatment  of  these  accounts  at  the  end  of  the  ac- 
counting period,  consists  merely  in  crediting  them  in- 
dividually with  the  portion  applicable  to  the  operations 
the  result  of  which  it  is  intended  to  ascertain,  and  debiting 
profit  and  loss,  or  group  accounts  raised  to  be  apportioned 
to  other  general  classes  of  facts. 

Desire  for  analytical  expression  of  financial  facts  has 
often  led  accountants  to  classify  deferred  debits  in  ac- 
cordance with  the  effect  which  they  will  have  upon  the 
financial  statements  of  future  periods.  They  have  at 
times  been  stated  as  follows: 

1.  Deferred  debits  to  Operating  Expenses 

2.  Deferred  debits  to  Deductions  from  Income 

3.  Deferred  debits  to  Profit  and  Loss 

Organization  Expense 

What  the  components  of  each  group  of  deferred  debits 
will  be,  depends  naturally  upon  the  peculiarities  of  the 
business.  To  illustrate,  as  to  group  3,  one  of  the  most 
familiar  of  the  factors  which  it  may  contain,  is  organiza- 
tion expense. 

At  the  birth  of  a  corporation,  a  multitude  of  expenses 
are  incurred  which  are  necessary  to  fulfill  statutory  re- 
quirements, and  to  set  in  motion  the  mechanism  of  the 
corporate  body  and  the  operations  of  its  business. 

The  first  group  of  such  expenses  includes  the  fees  paid 
for  incorporation,  and  for  the  filing  and  acknowledging  of 
papers. 

The  second  group  includes  the  fees  paid  to  the  pro- 
moter for  his  services,  and  to  the  lawyer  for  conducting 
the  organization  in  a  legal  manner;  also  the  cost  of  print- 
ing and  circulating  prospectuses,  and  of  soliciting  sub- 
scriptions; the  cost  of  acquiring  the  necessary  corporate 
equipment,  such  as  corporate  records,  seal,  etc.;  the  cost 


DEFERRED    DEBIT    ITEMS 


317 


of  printing  and  issuing  certificates  of  stock,  and  the  cost 
of  conducting  the  temporary  office  of  the  company  pend- 
ing organization. 

The  third  group  includes  perhaps  the  cost  of  inducing 
skilled  superintendents,  foremen,  and  workingmen  to 
abandon  their  present  occupation,  and  to  enter  the  em- 
ploy of  the  company. 

There  is  no  doubt  that  the  benefits  derived  by  the 
corporation  from  these  expenditures  will  be  felt  so  long 
as  it  remains  actively  engaged  in  business.  This  is  so 
true  that  the  Italian  law  does  not  permit  corporations  to 
write  off  their  organization  expenses  otherwise  than  pro- 
portionally during  their  official  life,  which  extends  for 
fifty  years.  In  America,  where  perpetuity  of  corporate 
life  is  usually  granted,  it  would  not  be  possible  to  apply 
such  a  rule.  On  the  other  hand,  unless  the  expenses  of 
organization  are  written  off  during  a  certain  number  of 
periods,  the  balance  sheet  will  forever  contain  an  asset 
which  has  no  salable  value  and  which  does  not  in  any  way 
tend  towards  the  proper  presentation  of  the  financial 
status.  Hence,  it  is  customary  to  arbitrarily  fix  a  number 
of  years  for  the  amortization  of  organization  expenses. 
This  is  done  by  periodically  crediting  the  account  with 
the  desired  proportion,  and  charging  profit  and  loss. 

The  PubHc  Service  Commission  for  the  first  district 
of  the  State  of  New  York  prescribes  that  the  corpora- 
tions organizing  under  its  jurisdiction,  keep  an  account 
with  "Organization,"  to  which  shall  be  charged  "all  fees 
paid  to  governments  for  the  privilege  of  incorporation, 
and  all  office  and  other  expenditures  incident  to  organ- 
izing the  corporation  or  other  enterprise  and  putting  it 
in  readiness  to  do  business."  On  the  other  hand,  the 
Interstate  Commerce  Commission  requires  that  these  ex- 
penses be  included  in  the  cost  of  construction  and 
equipment.     In  Austria  and  Hungary  the  corporation  is 


3i8 


THE    THEORY    OF    THE    ASSET    ACCOUNTS 


permitted  to  assess  stockholders  in  the  amount  necessary 
to  wipe  off  the  expenses  incident  to  the  organization  of 
the  company,  while  in  Germany  the  same  purpose  is  ob- 
tained by  selling  stock  at  a  premium  calculated  to  defray 
the  cost  of  organizing. 


Part  IV — The  Theory  of  the  Liability  Accounts 

CHAPTER  XXVII 

CAPITAL     STOCK 

The  Share  and  Its  Functions 

In  America  a  corporation  may  exist  without  issuing, 
under  the  form  of  shares,  evidences  of  the  contribution 
of  capital  by  its  members;  it  is  understood,  however,  that 
in  order  that  such  corporations — which  are  known  as 
"corporations  aggregate" — may  enjoy  a  perpetuity  of  life, 
the  rights  of  the  original  members  to  the  capital  con- 
tributed by  them,  shall  pass  to  their  successors  together 
with  the  property  acquired  out  of  capita^  and  with  the 
corporate  privileges. 

Generally  speaking,  corporations  issue  shares  of  stock 
to  their  stockholders,  which,  at  the  time  of  such  issue, 
indicate  the  extent  of  the  contributions  of  the  stock- 
holders, and,  thereafter,  the  proportion  in  which  the 
holders  whose  names  are  registered  on  the  corporate 
books  will  participate  in  the  distribution  of  profits  while 
the  company  continues  as  a  going  concern,  and  in  the 
remainder  of  the  assets  and  surplus  after  liquidation  of 
the  liabilities  at  winding  up. 

Lindley,  in  his  work  on  "Partnerships,"  refers  to 
capital  stock  as  follows:  "When  a  company  is  formed, 
a  sum  of  money  is  fixed  upon,  and  is  called  its  capital; 
this  sum  is  divided  into  a  number  of  equal  portions;  each 

319 


320    THE   THEORY   OF   THE   LIABILITY    ACCOUNTS 

of  these  portions  is  a  share,  and  whether  the  sum  fixed 
upon  is  ever  all  subscribed  or  not,  and  whether  what  is 
subscribed  is  employed  profitably  or  to  the  contrary,  a 
share  retains  its  original  meaning." 

If  a  share  of  stock  has  a  meaning  when  issued,  that 
meaning  must  be  that  the  legal  entity  which  issues  the 
document  intends  it  as  an  evidence  of  its  indebtedness  to 
the  original  holder,  his  heirs,  or  assigns,  for  the  net  assets 
acquired  out  of  the  capital  originally  contributed  and  out 
of  the  reinvestment  of  undivided  profits.  If  this  were 
not  true,  the  legal  doctrine  which  holds  that  the  title  to 
the  assets  of  a  corporation  rests  in  the  corporation,  would 
be  meaningless,  and  the  stockholders  would  be  tenants  in 
common,  precisely  like  partners. 

Capital  Stock  as  a  Liability 

The  fact  that  capital  stock  is  truly  a  liability,  is  in- 
sisted upon,  because  of  the  spread  in  recent  years  of  an 
academic  theory  which  attempts  to  establish  a  distinction 
between  "liabilities"  and  "accountabilities."  It  main- 
tains that  capital  stock,  surplus,  and  reserves  are  "ac- 
countabilities" which  merely  measure  the  extent  of  the 
stockholder's  "proprietorship"  in  the  assets  of  the 
corporation.  It  makes  the  corporate  balance  sheet  sub- 
servient to  the  following  formula  of  double-entry  book- 
keeping, which  is  only  expressive  of  the  nature  of  the 
proprietor's  equity :  "Assets  less  liabilities,  equal  proprietor- 
ship." 

So  far  as  sole  traders  are  concerned,  they  are  un- 
questionably the  owners  of  that  part  of  the  assets  which 
will  not  be  consumed  for  the  liquidation  of  liabilities. 
Hence,  for  these  two  classes  of  business  organization,  the 
balance  sheet  is  nothing  more  than  the  classified  and 
detailed  expression  of  the  above-mentioned  bookkeeping 
formula. 


CAPITAL    STOCK  334 

The  proprietors  have  invested  in  the  business  the 
whole  or  part  of  their  wealth,  consisting  of  real  or  personal 
property,  or  both;  their  business  is  not  an  entity  which 
the  law  recognizes;  it  is  not  a  "person"  in  any  sense  oi 
the  word,  not  even  in  contemplation  of  law;  it  owns 
nothing,  owes  nothing,  and  is  nothing.  The  expression 
"My  business  is  prosperous"  means  nothing  more  than 
*T  am  prosperous  in  business."  The  invested  assets  of  ^ 
sole  trader  may  be  seized,  upon  due  process  of  law,  by 
anybody  who  has  a  valid  claim  against  the  owners  of  the 
equity  in  the  investment,  as  measured  by  the  result  of 
the  subtraction  of  the  liabilities  from  the  assets. 

As  to  copartnerships  the  same  rules  apply,  with  this 
exception:  they  are  entities  which  the  law  recognizes  only 
to  the  extent  of  permitting  the  individual  creditors  of 
the  partners  to  share  only  in  the  assets  which  have  not 
been  used  to  liquidate  the  debts  of  the  copartnership. 

The  corporation,  on  the  other  hand,  is  an  entity,  none 
the  less  real  because  it  is  invisible  and  intangible.  It  ii 
a  legal  being  invested  with  a  written  permit  to  exist,  to 
possess,  to  contract,  to  sue,  to  be  sued,  and,  generally 
speaking,  to  conduct  the  particular  business  for  which  it 
is  created. 

To  fulfill  its  purpose  a  corporation  requires  capital 
Since  it  has  nothing  at  birth  but  the  power  to  act  as  » 
human  being  for  a  far  longer  period  and  with  a  greatei 
continuity  of  purpose  than  is  the  lot  of  mortals,  it  must 
obtain  capital  through  the  contributions  of  those  who 
believe  in  its  ultimate  fortunes  and  in  the  adequacy  of 
its  special  organism  for  the  fulfillment  of  its  particular 
purpose;  or  if  this  is  not  sufficient,  it  must  finance  itsell 
as  best  it  can,  by  pledging  as  security  the  assets  obtained 
through  the  investment  of  moneys  contributed  by  it? 
sponsors.  It  goes  without  saying  that  if  it  were  true 
that  the  stockholders  own  the  corporate  assets,  the  cor 


322    THE    THEORY   OF    THE    LIABILITY    ACCOUNTS 

poration  could  not  violate  the  law  and  pledge  that  which 
it  does  not  own.  Indeed,  the  peculiarity  of  the  status  of 
the  legal  being  known  as  the  corporation,  is  that  it  owes 
everything  which  it  owns. 

To  show  to  what  extent  the  anonymous  sponsors  of 
the  corporation  have  equipped  it  with  its  original  capital, 
there  is  issued  to  them  shares  of  capital  stock  which  be- 
come the  personal  property  of  the  stockholders,  precisely 
as  the  assets  acquired  by  means  of  that  capital  become 
the  real  or  the  personal  property  of  the  corporation. 

The  issue  of  stock  measures  the  extent  of  the  cor- 
poration's liability  for  original  capital,  or  for  subsequent 
increases  thereof.  The  stockholders  hold  that  evidence 
of  the  corporate  liability  to  them,  but  they  have  absolutely 
no  title  to  the  assets.  They  cannot  re-enter  into  posses- 
sion of  them  otherwise  than  by  causing  the  death  of  the 
legal  being  whose  birth  they  have  brought  about.  Their 
individual  creditors  cannot  seize  any  asset  of  the  corpora- 
tion to  satisfy  their  claims  against  the  stockholders. 
They  can,  however,  by  due  process  of  law,  secure  for 
themselves  the  stockholdings  of  their  debtors.  These 
stockholdings  measure  their  owner's  evidence  of  the  cor- 
poration's liability: 

1.  At  winding  up,  for  money,  property,  or  services 

originally  contributed,  as  represented  by  the 
capital  stock  outstanding,  expressed  at  par. 

2.  Also  at  winding  up,  or  at  any  time  deemed  ad- 

visable by  the  corporation  speaking  through  its 
directorate,  for  increments  arising  from  the  re- 
investment of  undivided  profits,  as  measured  by: 

a.  The  surplus 

b.  Such  reserves  as  do  not  contain : 

(i)  Losses  temporarily  withheld  from  the 
asset  which  they  would  otherwise 
reduce  (reserves  charged  to  cost) 


CAPITAL    STOCK  ^2^ 

(2)  Losses  incurred  but  not  as  yet  paid 
through  the  outgo  of  an  asset 
(operating  reserves  such  as,  "For  In- 
juries") 

i.e.,  all  the  reserves  appropriated  out 
of  surplus. 


Capital  Stock  Records 

The  rights  of  the  stockholders  to  the  benefits  accruing 
from  the  profitable  employment  of  the  capital  represented 
by  their  shares,  is  closely  safeguarded  by  statutes.  The 
total  amount  of  the  capital  stock  indebtedness  which  the 
corporation  may  incur,  is  well  known,  since  the  charter 
states  it,  and  it  cannot  be  increased  in  violation  oi  the 
rights  of  the  original  contributors.  Indeed,  if  the 
authorized  amount  of  capital  stock  is  overissued,  the  pur- 
chasers of  the  excess  do  not  acquire  any  rights  whatever 
as  stockholders,  although  they  may  have  a  cause  of  action 
for  damages  against  the  corporation  for  any  harm  done 
to  them.  Thus,  so  far  as  accounting  is  concerned,  the 
financial  books  of  a  corporation  must  be  so  kept  as  to 
reflect  at  all  times  the  authorized  issue  of  capital  stock, 
the  amount  actually  issued,  and  the  balance  unissued, 
otherwise  known  as  "potential  stock."  This  can  be  done 
in  two  ways: 

I.  At  the  time  of  opening  the  books,  make  a  pro 
forma  journal  entry  stating  fully  the  authorized  issue, 
divided  into  as  many  classes  of  stock  as  the  charter  con- 
templates, and,  thereafter,  frame  an  explicit  pro  forma 
entry  whenever  an  authorization  to  increase  the  issue  is 
obtained.  When  this  is  done,  a  reference  to  the  journal 
will  give  the  total  authorized  issue,  even  though  the 
minute  book  is  not  available.  As  to  the  portion  of  that 
authorized  issue  which  is  actually  outstanding,  it  will  be 


324 


THE    THEORY   OF    THE    LIABILITY    ACCOUNTS 


given  by  the  sundry  accounts  with  the  sundry  classes  of 
capital  stock,  which  will  be  credited  at  the  time  of  issuing. 
Expressed  in  journal  form,  the  requirements  of  this 
method  might  appear  as  follows: 

The  a.  B.  C.  Company 


General  Journal 

January  2,  1914 
The  A.  B.  C.  Company,  incorporated  under 
the  laws  of  the  State  of  New  York,  with  an 
authorized  capital  stock  of  five  hundred  thou- 
sand dollars  ($500,000)  divided  into  five  thou- 
sand (5,000)  shares  of  common  stock,  of  the 
par  value  of  one  hundred  dollars  ($100)  per 
share,  with  express  and  implied  power  to  con- 
duct a  general  manufacturing  business. 

Cash    $  75,000.00 

Property,  Plant,  and  Sundry  Assets 325,000.00 

To  Capital  Stock $400,000.00 

For  issue  of  capital  stock  in  consideration  of 
cash  subscriptions  to  750  shares  and  of 
property,  plant,  and  sundry  assets  acquired 
from  John  Harrison,  as  per  contract  on 
file. 

The  balance  sheet  of  the  company  would  show : 

Balance  Sheet 


Assets 

Cash  $  75,000.00 

Property,    Plant,    and 
Sundry  Assets 325,000.00 


$400,000.00 


Liabilities 

Capital  Stock 
Authorized .  $500,000.00 

Less  Unis- 
sued    100,000.00 


Issued  and  Outstanding.$400,ooo.oo 
$400,000.00 


CAPITAL    STOCK 


325 


2.  When  opening  the  books,  state  the  "potential  stock" 
as  a  debit  representing  the  right  of  the  company  to  issue 
the  stock,  and  as  a  credit  representing  the  extent  of  the 
stock  liability  which  the  corporation  has  been  authorized 
to  incur.  The  names  to  be  borne  by  the  two  classes  of 
statistical  accounts  may  be : 
Debits: 

Unissued  Capital  Stock — Common 
Unissued  Capital  Stock — Preferred 
Credits: 

Capital  Stock  Authorized — Common 
Capital  Stock  Authorized — Preferred 
Subsequently,  when  capital  stock  is  issued,  debit  the 
particular  asset  obtained  as  a  consideration  for  the  issue, 
and  credit  the  "unissued"  account.  By  itself,  the  balance 
of  the  unissued  account  represents  the  extent  of  the  poten- 
tial stock,  and  when  deducted  from  the  "authorized"  ac- 
count, it  measures  the  actual  capital  stock  liability  of  the 
corporation. 

Authorized  Capital  Stock — Common 


Unissued  Capital  Stock 
— Common    $500,000.00 


Unissued  Capital  Stock — Common 


Authorized   Capital 
Stock — Common  . . .  $500,000.00 


Cash  $  75,000.00 

Property,    Plant,    and 
Sundry  Assets 325,000.00 


Cash 


Unissued  Capital  Stock 
— Common $75,000.00 


Property,  Plant,  and  Sundry  Assets 


Unissued  Capital  Stock 
— Common $325,000.00 


326 


THE   THEORY   OF  THE   LIABILITY    ACCOUNTS 


If  all  the  authorized  issue  of  capital  stock  has  been 
subscribed,  partially  paid  for,  and  issued  subject  to  subse- 
quent calls,  the  whole  authorized  issue  constitutes  a  lia- 
bility of  the  corporation  and  must  be  so  stated.  The  rea- 
son for  this  accounting  treatment  is  to  be  found  in  the 
spirit  of  the  law  regulating  corporate  bodies.  A  sub- 
scriber to  capital  stock  who  has  received  the  stock  upon 
partial  payment  of  its  price,  has  no  power  to  surrender  his 
shares.  Corporations  may,  indeed,  exercise  the  power  to 
make  bona  fide  compromises  with  subscribers  when  their 
doing  so  does  not  jeopardize  the  interest  of  third  parties; 
they  may  also  forfeit  the  shares  issued  to  individual  stock- 
holders who  have  defaulted  on  the  payment  of  calls  legally 
made;  but  generally  speaking,  the  doctrine  prevails  that 
corporations  have  not  power  to  release  a  subscriber  from 
the  obligations  incurred  under  his  subscription  contract. 
The  reason  for  the  denial  of  that  right  is  that  the  unre- 
strained exercise  thereof  would  work  to  the  prejudice  of 
other  subscribers  and  creditors. 

If  all  the  stock  has  been  subscribed,  partially  paid  for, 
and  issued  subject  to  subsequent  calls,  the  application  of 
the  requirements  of  the  second  method  described  above 
will  give: 


Capital  Stock  Authorized 

(One  account  for  each  class  of  stock) 


Unissued       Capital 
Stock $500,000.00 


Unissued  Capital  Stock 

(One  account  for  each  class  of  stock) 


Capital  Stock  Author- 
ized   $500,000.00 

Capital      Stock 
scribed  

Sub- 
$500,000.00 

CAPITAL    STOCK 


3^7 


Subscriptions  to  Capital  Stock 

(One  account  for  each  call) 


Capital      Stock      Sub- 
scribed   $500,000.00 


$500,000.00 


Calls  I  and  2 $250,000.00 

Balance    (Uncalled 
subscriptions) 250,000.00 


$500,000.00 


Balance $250,000.00 

Capital  Stock  Subscribed 

(One  account  for  each  class  of  stock) 


Unissued      Capital 

Stock $500,000.00 


Subscriptions  to  Capi- 
tal Stock $500,000.00 


Cash 


Subscriptions  to  Capi- 
tal Stock,  Calls  I 
and  2 $250,000.00 


and  the  balance  sheet  expressing  the  above  facts  will  be : 
Balance  Sheet 


Assets 

Cash  $250,000.00 

Uncalled  Subscriptions    250,000.00 


$500,000.00 


Liabilities 

Capital  Stock  Author- 
ized, issued  and  out- 
standing    $500,000.00 


$500,000.00 


If  all  the  authorized  issue  of  capital  stock  has  been  sub- 
scribed, and  partially  paid  for,  and  the  stock  remains  un- 
issued until  all  the  subscriptions  have  been  paid,  the  facts 
will  be  expressed  as  follows: 

Capital  Stock  Authorized 


Unissued  Capital  Stock.$500,ooo.oo 


328    THE   THEORY    OF   THE   LIABILITY    ACCOUNTS 
Unissued   Capital   Stock 


Capital  Stock  Author- 
ized   $500,000.00 


Subscriptions  to  Capital  Stock 


Capital     Stock     Sub- 
scribed   $500,000.00 


Cash  $250,000.00 


Capital  Stock  Subscribed 


Subscriptions  to  Capi- 
tal Stock  $500,000.00 


Cash 


Subscriptions  to  Capi- 
tal Stock $250,000.00 


and  the  balance  sheet  will  show: 

Balance  Sheet 


Assets 

Cash  $250,000.00 

Uncalled  Subscriptions    250,000.00 


$500,000.00 


Liabilities 

Capital  Stock 
Authorized .  $500,000.00 

Less :  Unis- 
sued    500,000.00 


Capital       Stock      Sub- 
scribed     $500,000.00 


$500,000.00 


This,  it  will  be  noticed,  is  equivalent  to  stating  that 
the  corporation  is  not  as  yet  liable  to  stockholders  for 
stock  issued,  but  that  it  will  become  so  liable  to  them  as 
soon  as  they  have  performed  their  share  of  the  subscrip- 
tion contract. 


CAPITAL    STOCK  329 

The  Status  of  Unissued  Stock 

Teachers  of  accounting  maintain  that  unissued  capital 
stock  is  expressive  of  nothing  but  a  corporation's  right  of 
issue  under  its  charter;  that  it  is  not  an  asset  any  more 
than  the  admitted  capabiHty  of  an  individual  to  earn 
$10,000  a  year  is  an  asset  of  his  until  he  has  actually 
earned  the  amount;  that  it  is  not  a  liability  any  more  than 
the  possibility  of  mortgaging  a  parcel  of  real  estate  is  a 
liability  until  a  sum  of  money  has  been  borrowed  and  the 
property  has  actually  been  mortgaged.  If  their  conten- 
tion is  based  upon  the  status  of  the  certificates  still  at- 
tached to  the  stubs  in  the  stock  certificate  book,  it  is 
undoubtedly  true.  If,  however,  the  certificates  have  been 
detached  from  the  stubs,  signed,  sealed,  assigned  in  blank, 
and  placed  with  transfer  agents  or  other  financial  officers, 
ready  for  sale  and  delivery,  there  is  at  least  one  excellent 
reason  for  considering  the  shares  they  represent  both  as 
an  asset  and  as  a  liability;  it  is  that  the  Interstate  Com- 
merce Commission  requires  that  they  be  so  treated  for 
balance  sheet  purposes.  On  page  26  of  its  pamphlet 
"Form  of  General  Balance  Sheet  Statement  for  Steam 
Roads,"  and  under  the  subheading  "Capital  Stock"  of  the 
general  heading  "Liabilities,"  it  says: 

"The  amounts  included  in  this  account  should  be 
divided  so  as  to  show:  (i)  The  par  value  of  certificates 
(pledged  or  unpledged)  held  in  the  company's  treasury, 
by  its  agents  or  trustees,  or  otherwise  subject  to  its  con- 
trol." On  the  same  page,  there  is  a  footnote  to  the  effect 
that,  "for  the  purposes  of  the  balance  sheet  statements, 
stock  is  considered  as  'issued'  when  certificates  are  signed 
and  sealed,  and  placed  with  the  proper  officer  for  sale  and 
delivery." 

Premiums  on  Capital  Stock 

Generally    speaking,    statutes    do    not    permit    capital 


330    THE   THEORY   OF  THE   LIABILITY   ACCOUNTS 

stock  to  be  issued  for  less  than  par;  hence,  so  far  as  the 
issue  of  stock  to  subscribers  is  concerned,  it  is  unusual 
for  a  corporation  to  incur  a  capital  stock  liability  greater 
than  the  consideration  therefor.  It  is,  however,  quite  fre- 
quent that  subscriptions  realize  more  than  the  par  value 
of  the  stock.  How  are  the  premiums  on  stock  to  be  con- 
sidered, in  the  light  of  the  principle  that  the  capital  stock 
liability  is  to  be  carried  at  par  ? 

Premiums  realized  on  capital  stock  are  neither  income 
nor  profits,  since  the  word  income  means,  that  which  has 
come  in  as  a  result  of  the  investment  of  capital  in  any 
form  whatever;  while  the  word  profit  means  that  which 
has  come  in,  in  excess  of  the  cost  of  the  capital  which  has 
been  sold.  Premiums  do  not  represent  the  excess  of  cap- 
ital obtained  in  exchange  for  a  liability,  but  the  excess  ob- 
tained over  the  par  value  of  the  shares  of  stock  expressive 
of  that  liability.  This  is  true  in  any  event;  it  does  not 
matter  whether  the  premiums  were  obtained  at  the  time 
of  the  original  subscription,  or  subsequently  upon  the  sale 
of  the  unsubscribed  portion  of  the  original  authorized 
issue,  or  again  upon  sale  of  a  properly  authorized  in- 
creased issue. 

The  treatment  of  premiums  on  capital  stock  as  a  profit, 
places  the  corporation  in  the  position  of  admitting  that  it 
has  been  guilty  of  sharp  practices  upon  its  stockholders.  As 
a  consequence,  it  will  have  to  return  to  the  stockholders  that 
which  it  has  exacted  from  them  in  excess  of  the  par  value 
of  the  liability  which  it  has  incurred  towards  them.  If 
dividends  are  declared  out  of  premiums  on  capital  stock, 
and  the  cash  which  the  premiums  placed  at  the  disposal  of 
the  corporation  is  returned  to  the  stockholders,  where  is  the 
advantage  of  such  financing? 

Premiums  on  capital  stock  should  no  more  be  sent  to 
the  credit  of  the  Profit  and  Loss  account  than  they  should 
be  sent  to  the  surplus  available  for  dividends.     It  has  been 


CAPITAL    STOCK  33 1 

suggested  that  they  be  credited  to  a  special  account  so  ear- 
marked as  to  indicate  that  it  is  not  available  for  distribu- 
tion. But  is  not  this  an  admission  that  these  premiums  con- 
stitute a  liability  of  the  corporation  ?  As  a  matter  of  fact, 
premiums  obtained  on  the  issue  of  stock  which  has  a  par 
value  are  a  capital  stock  liability  precisely  as  they  would 
be  if  the  stock  had  no  par  value,  and  there  was  no  account- 
ing objection  to  stating  the  capital  stock  at  the  amount  of 
its  proceeds.  And  is  it  not  because  the  fact  that  premiums 
on  capital  stock  constitute  a  Hability,  cannot  be  denied,  that 
the  Interstate  Commerce  Commission  requires  that  they  be 
treated  as  such  by  the  public  service  corporations  which 
come  under  its  jurisdiction?  The  commission  has  ruled  as 
follows :  "When  any  issue  of  capital  stock  is  sold  or  ex- 
changed by  or  for  the  respondent  company  for  a  considera- 
tion the  actual  value  of  which  exceeds  the  par  value  of  the 
stock  at  the  time  of  such  sale  or  exchange,  the  premium  so 
realized  should  be  credited  to  a  ledger  account  provided  for 
discounts  and  premiums  on  all  classes  of  stock  sold.  If  the 
net  balances  in  the  accounts  for  discounts  and  premi- 
ums on  all  classes  of  stock  sold  is  a  credit  balance,  the 
amount  should  be  included  in  this  account.  This  balance 
should  be  carried  permanently  on  the  balance  sheet  unless 
extinguished  by  discounts  suffered  on  subsequent  sales  of 
stock,  or  by  retiring  stock.  When  any  stock  is  retired,  the 
proper  discounts  and  premiums  account  should  be  adjusted 
by  debiting  it  with  an  amount  equal  to  the  extinguished 
premium  on  such  stock." 

Discount  and  Premium  Accounts 

If  premiums  are  to  be  carried  permanently  on  the  credit 
side  of  the  balance  sheet,  it  follows  that,  for  the  sake  of  con- 
sistency, discounts  should  be  carried  permanently  on  the 
asset  side  as  a  partial  offset  to  the  liability  expressed  at  the 
par  of  the  shares,  instead  of  being  debited  to  profit  and 


332    THE   THEORY   OF  THE   LIABILITY    ACCOUNTS 

loss,  in  either  a  lump  sum  or  throughout  a  period  of  years. 
The  net  amount  paid  by  the  stockholders  for  their  stock  is 
indeed  that  which  they  may  expect  to  receive  at  winding  up, 
irrespective  of  the  dividends  declared  in  the  past.  This  is 
true  whether  or  not  the  company  has  legally  or  illegally  ac- 
cepted as  payment  in  full  the  consideration  for  the  stock 
paid  by  the  stockholder. 

In  regard  to  discounts  on  capital  stock,  the  Interstate 
Commerce  Commission  has  ruled  that  "if  the  net  of  the 
balances  in  the  discounts  and  premiums  accounts  for  all 
classes  of  capital  stock  sold  is  a  debit  balance,  the  amount 
should  be  stated  in  this  account  (Unextinguished  Discount 
of  Capital  Stock),  This  balance  should  be  carried  on  the 
balance  sheet  (asset  side)  until  extinguished  by  premiums 
realized  on  subsequent  sales  of  stock,  by  assessments  levied 
on  the  stockholders,  by  appropriations  of  income  or  free  sur- 
plus for  the  purpose,  or  by  retiring  the  stock.  When  any 
stock  is  retired,  the  proper  discount  and  premium  account 
should  be  adjusted  by  crediting  to  it  an  amount  equal  to  the 
unextinguished  discount  on  such  stock." 

Treasury  Stock 

Capital  stock  which  has  been  legally  issued  is  looked 
upon  by  the  law  as  a  liability  of  the  corporation  issuing  it, 
until  it  has  been  liquidated,  on  the  winding  up  of  the  cor- 
poration, through  the  distribution  to  the  stockholders  of  the 
remainder  of  the  assets  after  liquidation  of  all  liabilities  to 
outsiders,  or  until  it  has  been  legally  canceled  after  author- 
ization given  by  the  stockholders  assembled  at  a  meeting 
legally  called  to  consider  the  cancellation.  It  follows  that 
if  stock  has  been  acquired  in  the  open  market  by  the  company 
responsible  for  its  issue,  in  pursuance  of  some  financing 
scheme,  or  donated  to  the  company  by  the  stockholders  to  be 
resold  for  the  purpose  of  obtaining  additional  capital,  such 
stock  must  be  an  asset.     It  is  not  "potential  stock,"  since 


CAPITAL    STOCK  ^^^ 

it  has  been  issued;  it  is  "actual  stock"  held  in  the  treasury 
pending  disposition.  It  is  usually  carried  as  "treasury 
stock,"  but  the  term  does  not  seem  to  be  satisfactory,  be- 
cause it  conveys  to  many  the  idea  that  it  represents  stock  held 
in  the  treasury,  whether  or  not  it  was  once  issued.  It  might 
be  more  in  keeping  with  the  efforts  of  modern  accountancy 
to  make  financial  statements  intelligible  both  to  the  layman 
and  to  the  professional  accountant,  if  stock  acquired  by,  or 
donated  to,  the  issuing  company  were  to  be  called  "stock 
issued,  acquired  (or  donated),  and  held  in  the  treasury," 
or  "actual  stock  held  in  the  treasury." 

If  stock  which  has  been  legally  issued  and  has  come  back 
into  the  treasury  is  subsequently  canceled  upon  due  author- 
ization of  an  assembly  of  stockholders,  it  ceases  to  be  treas- 
ury stock ;  it  reduces  the  liability  for  outstanding  stock,  and 
becomes  potential  stock  precisely  like  the  previous  balance 
(if  any)  of  the  unissued  authorized  capital  stock. 

Accounting  for  Treasury  Stock 

A  business  concern  acquiring  its  own  stock  in  the  open 
market,  either  to  sell  it  later  at  a  higher  price  than  was 
originally  obtained  therefor,  or  to  avoid  the  payment  of 
large  dividends  earned  and  about  to  be  declared,  will  in  all 
probability  carry  treasury  stock  at  par,  since  its  par  value  is 
the  exact  counterpart  of  the  liability  therefor,  expressed  at 
par.  If  the  price  paid  has  been  greater  or  smaller  than 
par,  it  may  debit  or  credit  the  "loss"  or  the  "gain"  to  the 
Profit  and  Loss  account,  or  carry  it  in  a  special  account, 
"Premiums  and  Discounts  on  Treasury  Stock,"  subject  to 
periodical  amortization.  The  result  of  such  an  accounting 
will  be  an  additional  profit  or  loss  for  the  period  during 
which  the  stock  was  purchased,  or  for  a  certain  number  of 
periods  thereafter.  But  if  that  additional  profit  or  loss 
means  anything,  it  means  that  by  "dabbling"  in  its  own 
capital  obligations  the  company  has  been  ben^ted  or  in- 


334    THE   THEORY   OF   THE   LIABILITY    ACCOUNTS 

jured  to  a  certain  extent.  No  matter  what  the  financing 
scheme  may  have  been  which  suggested  the  purchase  of 
stock,  its  purpose  should  have  been  accompHshed  without 
affecting  the  income,  since  the  question  of  reducing  the 
capital  stock  liability  was  never  at  issue.  It  would  undoubt- 
edly be  better  accounting  to  accept  the  view  that  premiums 
on  capital  stock  constitute  liabilities,  while  discounts  con- 
stitute assets,  or,  at  all  events,  that  they  represent  facts 
which  should  be  permitted  to  remain  on  the  books  until 
offset  by  subsequent  transactions.  Nor  can  it  be  said  that 
such  a  treatment  would  not  be  good  financing,  since  it  would 
compel  the  supposed  gains  on  discounts  to  remain  in  the 
business,  while  it  would  prevent  the  supposed  losses  on 
premiums  from  being  charged  to  the  present  stockholders  to 
the  possible  advantage  of  future  stockholders. 

Donation  Account 

A  business  concern  coming  into  possession  of  its  own 
stock  through  a  donation,  should  carry  the  stock  at  par  under 
the  term  'Treasury  Stock,"  and  create  a  credit  account  bear- 
ing an  appropriate  name,  as,  for  instance,  "Treasury  Stock 
Donation  Account,"  which  will  remain  open  so  long  as  all 
the  treasury  stock  is  not  disposed  of.  As  sales  occur,  the 
treasury  stock  account  should  be  credited  with  the  par 
value  of  the  shares  sold,  and  the  donation  account  debited 
with  the  discounts  and  credited  with  the  premiums,  if  any. 
If  treasury  stock  is  given  as  a  bonus  to  syndicates  under- 
writing issues  of  bonds,  or  to  purchasers  of  bonds  or  other 
classes  of  stock,  the  par  value  of  the  shares  so  given  should 
be  credited  to  the  treasury  stock  account  and  debited  to  the 
donation  account.  Thus,  when  all  the  treasury  stock  is 
disposed  of,  the  balance  of  the  donation  account  will  reflect 
the  exact  amount  of  working  capital  obtained  by  the  com- 
pany as  a  result  of  the  gift,  and  the  question  of  what  to  do 
with  the  donation  account  will  arise. 


CAPITAL    STOCK 


335 


If  the  balance  of  the  donation  account  is  sent  to  the  free 
surplus,  dividends  will  be  declared  therefrom  and  the  pur- 
pose of  the  donors  will  be  defeated.  If  the  balance  is  sent 
to  a  separate  surplus  account  so  earmarked  as  to  indicate  that 
it  is  not  available  for  dividends,  what  will  be  the  nature  of 
that  account  ?  It  has  been  suggested  that  it  practically  con- 
stitutes a  reserve  susceptible  of  being  transferred  to  surplus, 
if  required  to  offset  extraordinary  losses  of  a  given  period 
or  of  a  succession  of  periods.  This  may  be  "sentimental 
accounting"  but  it  has  no  other  quality.  It  fails  to  respect 
the  purpose  of  the  donation ;  it  jeopardizes  the  benefits  ob- 
tained thereby  in  so  far  as  it  makes  it  possible  to  declare 
dividends  which  will  have  to  be  paid  out  of  the  additional 
working  capital  obtained  as  a  result  of  a  gift  made  for  the 
welfare  of  the  corporation. 

In  reality,  the  donation  account  measures  the  extent  of 
the  benefit  derived  by  the  stockholders  present  and  to  come 
from  the  benevolent  action  of  one  or  several  of  them,  and 
constitutes  a  capital  liability  of  the  corporation  similar  in 
every  respect  to  the  liability  for  unextinguished  premiums 
obtained  through  the  sale  of  stock. 


CHAPTER  XXVIII 

BONDED    DEBT 

General  Considerations 

Taken  in  its  broadest  sense,  the  word  "debt"  means  a 
fixed  and  certain  sum  of  money  due,  or  owing,  by  virtue  of 
express  agreement.  The  distinction  between  "due"  and 
"owing"  has  been  established  by  a  California  judge*  as 
follows : 

"Standing  alone,  the  word  'debt'  is  as  applicable  as  well 
to  a  sum  of  money  which  has  been  promised  at  a  future  day, 
as  to  a  sum  of  money  now  due  and  payable.  If  we  wish  to 
distinguish  between  the  two,  we  say  of  the  former  that  it  is 
a  debt  owing,  and  of  the  latter  that  it  is  a  debt  due.  In 
other  words,  debts  are  of  two  kinds :  solvendum  in  praesenti, 
and  solvendum  in  futuro." 

The  same  judge,  speaking  of  the  nature  of  debts,  says 
in  the  same  case :  "Whether  a  claim  or  demand  is  a  debt  or 
not,  is  in  no  respect  determined  by  a  reference  to  the  time 
of  payment.  A  sum  of  money  which  is  certainly  and  in  all 
events  payable,  is  a  debt,  without  regard  to  the  fact  whether 
it  be  payable  now,  or  at  a  future  time.  A  sum  payable  upon 
a  contingency,  however,  is  not  a  debt,  or  does  not  become  a 
debt  until  the  contingency  has  happened." 

All  debts  which  are  evidenced  by  securities  of  a 
permanent  nature  and  for  the  payment  of  which  certain 
property  has  been  pledged,  are  generally  referred  to  as 
"funded  debt,"  even  though  it  be  true  that  the  term  appears 

*  Jn  People  v,  Arguello,  37  Gal.  524,  525. 


BONDED    DEBT  ^37 

to  suggest  that  the  payment  of  the  debt  is  secured  beyond 
peradventure  by  the  periodical  appropriation  of  money. 
Such  an  appropriation  may  or  may  not  exist ;  if  it  does  not, 
the  term  "funded  debt"  applies  just  as  surely  to  treasury 
bonds  and  stocks,  mortgage  bonds,  collateral  trust  bonds, 
equipment  certificates,  etc.,  etc.,  since  the  debt  is  to  all  intents 
and  purposes,  funded  through  the  pledge  of  a  particular 
property  which  may  be  converted  by  sale  into  cash  funds. 

In  this  book,  however,  it  has  been  deemed  advisable  to 
subdivide  funded  debt  as  follows : 

1.  Bonded  Debt,  i.e.,  all  debts  evidenced  by  bonds. 

2.  Mortgaged  Debt,  i.e.,  all  debts  evidenced  by  bonds 

secured  by  mortgages  on  real  estate  or  on  chattels. 

Bond  Issues 

Every  corporation  not  restricted  by  constitutional  pro- 
visions of  its  own  making  or  by  statute,  has  the  implied 
power  to  issue  bonds  as  evidence  of  indebtedness  incurred 
for  money  borrowed,  property  acquired,  labor  performed,  or 
financial  services  rendered  by  others  for  its  benefit. 

This  corporate  privilege  is  exercised  through  the  vote  of 
the  stockholders,  or,  if  the  latter  have  vested  part  of  their 
rights  in  the  directorate,  through  proper  resolutions  by  the 
board  of  directors. 

Bonds  are  authorized  to  be  issued  in  denominations  best 
suited  to  the  conditions  of  the  market  in  which  they  will  be 
offered  for  sale.  Issues  of  bonds  may  be  composed  of  units 
all  maturing  at  the  same  date,  or  of  a  series  of  units  each 
series  maturing  at  a  different  date;  in  the  latter  case,  the 
security  pledged  under  the  issue  as  a  whole  is  all  the  more 
attractive  because  the  retirement  of  a  particular  series 
usually  causes  the  part  of  the  pledge  securing  it  to  revert 
to  other  unmatured  series. 

The  mortgage  securing  the  bonds  is  frequently  issued  to 
one  or  several  trustees  who  hold  it  for  the  common  good 


338 


THE   THEORY   OF   THE   LIABILITY   ACCOUNTS 


of  the  bond  purchasers;  in  many  instances  the  indenture 
states  conditions  which  must  be  fulfilled  before  the  trustees 
are  allowed  to  certify  bonds  for  sale  to  the  public.  These 
provisions  are  common  in  modern  railroad  bonds  issued  for 
construction  purposes  where  the  trustee  can  only  certify 
such  instalments  as  cover  the  completion  to  date  of  a  stated 
part  of  the  construction. 

Accounting  Theories  of  Bond  Issues 

The  accounting  record  of  the  liability  incurred  under  an 
issue  of  bonds,  depends  upon  the  point  of  view  of  the 
accountant : 

I  Considering  the  potential  value  of  bonds  as  secured 
evidences  of  the  indebtedness,  and  accepting  them 
individually  as  pro  rata  representatives  of  a  valu- 
able mortgage,  he  may  give  to  the  unsold  part  of 
the  issue  an  asset  value  derived  from  its  potential 
pledge  value,  and,  for  financial  purposes,  treat  it 
as  an  asset. 

2.  He  may  hold  the  opinion  that,  being  executed  to  the 

trustee,  whether  or  not  subject  to  his  certification, 
the  unsold  portion  of  the  proposed  issue  differs 
from  the  sold  portion  only  in  the  fact  that  in  the 
latter  instance  the  cash  value  of  the  mortgage  has 
been  realized,  whereas  in  the  former  case  it  has 
not. 

3.  Ignoring  the  borrowing  power  inherent  in  the  un- 

sold instruments  of  credit,  and  refusing  to  be 
swayed  in  his  opinion  by  the  argument  that 
whether  or  not  the  whole  issue  is  sold  the  same 
amount  of  assets  remain  pledged,  he  may  rigidly 
enforce  the  rule  that  potentiality  does  not  mean 
actuality. 
Under  the  first  and  second  hypotheses,  the  accounting 
treatment  will  be  the  same ;  the  whole  authorized  issue  will 


BONDED    DEBT 


339 


be  carried  as  treasury  bonds,  and  at  the  same  time  as  a 
liability.  The  liability  will  remain  immutable  until  its 
maturity,  or  until  premature  cancellation  of  part  of  the 
evidence  of  indebtedness;  as  to  the  asset,  its  nature  will 
change  with  every  successive  sale. 

Under  the  third  hypothesis,  the  asset  and  the  liability 
will  be  recorded  only  at  such  time  as  the  former  has  been 
received  in  cash  through  sales. 

It  is  evident  that  either  of  the  above  treatments  would 
produce  the  same  impression  upon  the  reader  of  a  balance 
sheet  were  it  not  that,  thanks  to  theorists  and  philosophizers, 
the  general  public  has  come  to  give  to  the  term  "treasury 
bonds"  the  same  meaning  as  is  commonly  g^ven  to  "treasury 
stock."  The  layman  understands  treasury  bonds  to  be 
bonds  issued  and  subsequently  reacquired  by  the  issuing 
company.  The  objection  is  only  a  trivial  one,  however, 
since  for  balance  sheet  purposes  it  is  always  possible  to 
record  the  status  of  bonded  indebtedness  as  follows : 

First  Mortgage  5  per  cent  Bonds  of  1925 : 

Authorized $100,000.00 

Less  held  in  Treasury 40,000.00 


Issued  and  Outstanding. . .  $60,000.00 

Bonds  Acquired  by  Issuing  Company 

The  question  of  the  status  of  bonds  purchased  by  the 
issuing  company,  for  sinking  fund  purposes  or  for  any 
other  purpose,  has  usually  found  the  accountant  quite  in- 
different. Instinctively,  he  has  felt  that  it  is  of  bonds  as  it 
is  of  stocks,  i.e.,  neither  uncanceled  bonds  nor  uncanceled 
stocks  reduce  the  liability  of  the  issuing  company. 

Unquestionably,  if  the  purpose  in  acquiring  the  bonds  is 
to  hold  them  for  speculative  purposes,  the  liability  of  the 
company  remains  unaffected. 

But  when  we  come  to  consider  the  status  of  bonds  ac- 


340    THE   THEORY    OF  THE   LIABILITY    ACCOUNTS 

quired  by  the  issuing  company  for  the  purpose  of  the  sink- 
ing fund,  we  face  a  much  more  compHcated  situation.  It  is 
plain  that  at  maturity  of  the  bonds  the  liabiHty  will  auto- 
matically be  reduced  by  the  amount  of  the  par  value  of 
bonds  held  by  the  trustee  of  the  sinking  fund.  But  it  is 
just  as  plain  that  if  the  par  value  of  the  bonds  acquired 
under  the  sinking  fund  provisions  of  the  indenture  is  de- 
ducted from  the  liability,  the  accounting  correlation  which 
should  exist  between  the  sinking  fund  and  the  expired  por- 
tion of  the  life  of  the  bond  liability  representing  the  whole 
issue,  will  be  lost.  And  yet  the  bondholders  who  read  the 
balance  sheet  have  the  right  to  know  the  status  of  the 
sinking  fund. 

C.  S.  Ludlam,  C.  P.  A.  (N.  Y.),  writing  in  the  March, 
1914  number  of  the  Journal  of  Accountancy,  makes  a  plea 
for  the  acceptance  of  the  theory  that  sinking  funds  composed 
of  uncanceled  bonds  of  the  company  responsible  for  their 
issue  are  to  be  shown  as  deductions  from  the  liability. 

Mr.  Ludlam  says :  "It  is  appreciated  that  some  of  our 
legal  friends  will  claim  that  bonds  of  a  mortgagor,  of  the 
issue  covered  by  a  sinking  fund,  purchased  by  the  sinking 
fund  trustee  and  not  retired  and  canceled,  will  not  reduce  the 
obligation  of  the  mortgagor,  and  that  such  bonds  should  be 
treated  as  a  part  of  the  sinking  fund  and  shown  on  the 
balance  sheet  of  a  corporation  as  an  asset,  and  that,  contra 
thereto,  the  full  amount  of  the  bonds,  both  outstanding  and 
in  the  sinking  fund,  should  be  shown  as  a  liability.  It  is 
admitted  that  there  are  some  legal  reasons  for  this,  the 
chief  of  which  is  perhaps  the  question  of  legal  practice  in 
regard  to  the  burden  of  proof,  but  it  seems  to  me  that  ques- 
tions of  this  nature  could  arise  only  in  cases  of  receivership 
or  liquidation  and  would  have  to  be  dealt  with  only  under 
court  orders;  consequently  they  would  not  apply  to  the 
ordinary  accounting  of  a  going  concern.  Further,  while 
accountants  must  be  mindful  of  any  and  all  legal  obligations, 


BONDED    DEBT 


341 


and  of  any  legal  situation  afifecting  the  accounts  of  the 
clients,  it  will  be  apparent  at  once  to  anyone  who  gives  the 
matter  thought,  that  as  an  actual  fact  an  individual  cannot 
owe  money  to  himself." 

Many  people  have  given  thought  to  bond  accounting, 
and,  judging  from  the  rulings  of  the  Interstate  Commerce 
Commission,  the  commissioners  have  given  to  the  particular 
subject  of  sinking  funds  all  the  respectful  attention  which  it 
deserves.  A  sinking  fund  is,  after  all,  an  account  to  which 
nothing  else  can  happen  but  to  be  eventually  debited  to  the 
liability  for  the  redemption  of  which  it  is  created.  Hence, 
it  is  essentially  and  wholly  an  item  the  ultimate  disposition 
of  which  is  deferred  until  such  time  as  its  contra  will  mature. 
For  this  reason  public  utility  corporations  must  show  sink- 
ing funds  as  deferred  debit  items. 

Nobody  reading  a  balance  sheet  would  be  led  to  shrug 
his  shoulders  contemptuously  at  the  anomaly  presented  by 
a  sinking  fund  which,  if  examined  under  a  sophistical  micro- 
scope, would  elucidate  the  fact  that  it  contains  evidence  of 
indebtedness  of  the  company  to  itself.  One  would  simply 
understand  that,  no  matter  what  particular  asset  the  sinking 
fund  may  contain,  it  represents  an  accumulation  of  future 
debits  to  a  liability  account.  As  to  the  accountant,  he  would 
naturally,  knowing  the  date  of  issue  and  the  maturity  of  the 
bonds,  divide  the  total  liability  by  the  sum  of  its  life  in 
years  or  in  interest  periods,  or  in  accounting  periods,  multi- 
ply the  result  by  the  number  of  periods  of  expired  life  of 
the  liability,  and  judge  the  sinking  fund  in  the  light  of  the 
ratio  that  it  bears  to  the  liability  which  it  will  redeem. 

Premiums  and  Discounts  on  Bond  Sales 

When  bonds  have  been  sold  at  par,  the  recording  of  the 
liability  therefor  consists  in  expressing  it  at  the  same  figure 
as  the  asset  which  represents  the  proceeds  of  the  sale.  But 
when  bonds  are  sold  at  more,  or  at  less,  than  par,  there  has 


342    THE   THEORY   OF   THE   UABILITY    ACCOUNTS 

been  obtained  an  asset  greater  or  smaller  than  the  liability, 
and  we  must  record  the  extent  of  the  excess  or  of  the 
shortage  under  the  name  of  premiums  or  discounts  on 
bonds.  What  to  do  with  these  discounts  or  premiums  is 
one  of  the  most  interesting  of  the  problems  which  the  ac- 
countant has  to  solve. 

Let  us  state  at  once  that  the  universal  custom  is  to  credit 
the  premiums  and  debit  the  discounts  to  profit  and  loss, 
periodically,  during  the  life  of  the  bonds.  But  is  this  correct 
from  a  financing  as  well  as  from  an  accounting  point  of 
view? 

.  When  treating  of  investments  in  bonds,  we  have  seen 
that,  according  to  the  tenets  of  the  accountancy  of  invest- 
ment, bonds  assure  to  their  owners  the  return  of  the  prin- 
cipal invested,  and  a  periodical  effective  return  of  interest 
which,  in  the  case  of  bonds  purchased  at  a  premium,  is 
smaller  than  the  nominal  return ;  while  in  the  case  of  bonds 
purchased  at  a  discount  it  is  greater.  We  have  also  seen 
that,  in  the  case  of  premiums  on  bonds  the  theory  which 
holds  that  the  nominal  return  is  income,  is  a  fallacy,  as 
evidenced  by  the  disastrous  effect  that  it  has  upon  the  estate 
of  a  remainderman  under  the  provisions  of  a  will  directing 
the  executor  to  invest  the  principal  of  the  estate  in  bonds, 
to  pay  the  interest  to  a  life-tenant  and,  at  his  or  her  death, 
the  principal  to  the  remainderman.  We  have  demonstrated 
that  if  the  investor  must  make  his  income  reflect  the  rate  of 
interest  that  he  expected  on  his  investment,  he  must  amor- 
tize or  accumulate  the  cost  of  the  investment  to  par  through 
the  Interest  account. 

If  the  purchaser  of  bonds  above  par  must  reduce  the  cost 
of  his  investment  by  charging  his  income  with  the  periodical 
amount  to  be  amortized,  why  should  not  the  vendor  of  the 
bonds  amortize  tlte  premium  which  he  has  received,  by 
crediting,  not  his  Profit  and  Loss  account,  but  his  Interest 
account  ?    Is  it  not  true  that  the  effect  of  the  premium  is  to 


BONDED    DEBT 


343 


reduce  his  interest  charges,  whereas  the  effect  of  the 
discount  which  he  sustains  when  the  investor  obtains  a  dis- 
count, is  to  increase  his  interest  charges  ? 

To  make  this  plain  through  an  example :  If  the  accounts 
of  the  investor  show : 

Investment  in  Bonds 
5%  First  Mortgage  Bonds 


Interest 

Principal 

Date 

Nominal 

5% 

Effective 

4% 

Amor- 
tization 

Dr. 

Cr. 

Balance 

May    I,  1914. . .  . 
Nov.  I,  1914 

$1,250.00 

$1,044.91 

$205.09 

$52,245.64 

$205.09 

$52,040.55 

why  should  not  the  accounts  o^  the  company  show : 
First  Mortgage  5%  Bonds,  1914-1928 


1914 


May  I     Cash $50,000.00 

Premium  on  First  Mortgage  5%  Bonds,  1914-1928 


1914 

Nov.  I     Interest  on  Bonds..$205.09 


1914 
May  I     Cash $2,245.64 


Interest  on  Bonds 


1914 

Nov.  I     Cash 


.$1,250.00 


1914 
Nov.  I    Discount 


.$205.09 


Premiums  as  Deductions  from  Principal 

There  are  two  more  theories  to  be  considered  in  con- 
nection with  the  treatment  of  premiums  on  bonds:  One  is 
to  the  effect  that  premiums  obtained  on  bond  issues  should 


344    THE   THEORY   OF   THE   LIABILITY    ACCOUNTS 

be  set  aside  to  serve  as  the  nucleus  of  the  sinking  fund  for 
the  redemption  of  the  principal  at  maturity ;  the  other  states 
that  "the  premium  must  follow  the  principal,"  that  is  to  say, 
flMOSt  be  deducted  from  the  authorized  issue. 

It  will  be  noted  that  these  two  theories  are  similar  in 
principle ;  both  attempt  to  provide  for  the  partial  redemption 
of  the  debt.  Logical  as  both  may  appear  to  their  advocates, 
they  fail  to  take  into  consideration  the  intimate  relation 
which  should  exist  at  all  times  between  the  bonded  debt  and 
its  interest  cost. 

The  careful  student  of  accounting  must  be  impressed 
with  the  fact  that,  whatever  the  methods  of  treating  pre- 
miums and  discounts  may  be,  their  ultimate  result  is  the 
same  no  matter  what  their  intent  may  have  been. 

The  theory  which  applies  premiums  and  discounts  as 
additions  to,  or  deductions  from,  income,  allows  them  to 
contribute  to,  or  to  reduce,  the  amount  of  net  profits  out  of 
which  a  fund  will  be  created  for  the  redemption  of  the  debt, 
either  through  the  accumulation  of  a  reserve,  a  fund  out  of 
profits,  or  both. 

The  theory  which  applies  premiums  and  discounts  as  de- 
ductions from,  or  additions  to  interest  cost,  has  precisely  the 
same  effect,  and  the  same  is  true  of  the  theories  which  use 
premiums  either  as  a  sinking  fund  nucleus  or  as  a  partial  re- 
demption of  the  debt. 

The  great  question  at  issue  in  all  accounting  matters  is 
not,  however,  a  question  of  results,  but  it  is  one  of  illumina- 
tive sub- results.  It  is  evident  that  if  we  ignore  the  nominal 
accounts,  and  are  satisfied  to  deduct  the  liabilities  from  the 
assets  at  the  end  of  a  period,  and  compare  the  result  with 
that  of  the  prior  period  as  elucidated  by  a  similar  treatment 
of  the  balance  sheet,  we  shall  obtain  the  net  profit  or  loss  of 
the  period ;  and  nothing  that  we  could  do  would  change  the 
result.  But  we  have  failed  to  show  the  causes  which  have 
brought  about  the  result;  we  have  also  failed  to  show  the 


BONDED    DEBT 


345 


exact  status  of,  and  the  relation  between,  the  different  causes. 
Lastly,  we  have  failed  to  mention  facts  which,  if  known, 
and  known  to  be  true,  would  make  it  possible  to  pass  a  com- 
prehensive and  accurate  judgment  upon  the  operations  and 
the  financing  of  the  enterprise. 

Hence,  throughout  our  accounting  we  must  remember 
that  figures  which  are  not  capable  of  making  any  statement 
of  their  own,  and  can  only  vouch  for  the  accuracy  of  the 
final  result,  are  meaningless  and  worthless. 


CHAPTER   XXIX 

SECURED  DEBT UNSECURED  DEBT 

SECURED   DEBT 

Real  Estate  Mortgages 

"In  equity,  whatever  property,  real  or  personal,  is  cap- 
able of  an  absolute  sale,  may  be  the  subject  of  a  mortgage."* 
"A  mortgage  may  be  made  to  cover  both  real  and  personal 
property;  and  the  validity  of  a  mortgage  on  real  estate  is 
not  affected  by  the  fact  that  it  also  pledges  personal  prop- 
erty and  is  recorded  in  the  records  of  chattel  mortgages."! 
In  fact,  unless  statutes  prohibit,  a  mortgage  may  be  made 
to  cover  not  only  land  and  buildings,  but  machinery,  and 
even  profits  to  arise  from  the  operation  of  the  said  real  and 
personal  properties.  In  the  state  of  Louisiana,  where  the 
Code  Napoleon  prevails,  only  "immovable"  property  can  be 
mortgaged. 

Generally  speaking,  in  order  that  a  mortgage  given  by 
a  going  concern  may  be  valid  and  its  provisions  enforced,  it 
must  have  been  given  for  a  consideration  which,  in  point 
of  time,  may  be : 

1.  Received  at  the  time  of  the  execution  of  the  instru- 

ment 

2.  Receivable  at  some  future  time 

3.  Received  at  some  previous  time,  subject  to  condi- 

tions which,  being  unfulfilled,  are  canceled  in  con- 
sideration of  the  mortgage 

•Wright  V.  Shumway,  30  Fed.  Cases,  No.  18,093;  i  Bisr  2^A 
t  Long  V.  Cockern,  29  111.  App.  304. 


SECURED    DEBT 


347 


The  consideration  itself  may  be : 

1.  The  receipt  of  property  or  of  money  or  its  equivalent 

2.  The  granting  to  the  mortgagor  of  the  right  to  en- 

force the  mortgagee's  performance  of  a  contract 
for  future  delivery  of  money  when  certain  condi- 
tions are  fulfilled  by  the  mortgagor 

3.  The  extension  of  the  time  of  settlement  of  claims 

and  accounts  outstanding  against  the  mortgagor 

4.  The  surrender  by  the  mortgagee  of  securities  previ- 

ously pledged  to  him  as  a  security  for  a  debt  of 
the  mortgagor  which  is  to  be  extended 

1.  Receipt  of  Property  or  Money.  If  the  consideration 
has  been  the  receipt  of  property,  money,  or  its  equivalent, 
the  accounting  procedure  necessary  to  express  the  transac- 
tion on  the  books  of  the  mortgagor,  is  to  record  the  asset 
obtained  as  well  as  the  liability  incurred  therefor.  No  entry 
of  any  kind  is  made  in  the  account  recording  the  value  of  the 
asset  mortgaged,  since  the  conveyance  of  it  is  subject  to  a 
claim  which  defeats  it  if  certain  conditions  are  satisfied. 

2.  Mortgagor's  Right  to  Enforce  Contract.  If  the  con- 
sideration has  been  the  granting  to  the  mortgagor  of  a 
financial  right  to  be  exercised  at  some  future  time,  upon  the 
fulfilment  by  him  of  certain  conditions  (such  as  is  the  case 
with  building  loans),  the  mortgagor  may : 

a.  Record  his  financial  right  and,  correspondingly,  the 

long-term  liability  which  he  has  incurred  and  se- 
cured ;  subsequently,  when  exercising  his  right, 
debit  the  asset  received  and  correspondingly  de- 
crease the  right. 

b.  Omit  the  recording  of  the  right,  and  record  the  asset 

and  the  liability  only  at  the  time  the  asset  is 
actually  received.  Of  course,  in  this  case,  the 
amount  of  the  liability  recorded  is  precisely  that 
of  the  asset  received. 


348 


THE   THEORY    OF   THE    LIABiLITY- ACCOUNTS 


3.  Extension  of  Time.  If  the  consideration  has  been 
the  extension  of  the  time  of  settlement  of  claims  and  ac- 
counts outstanding"  against  the  mortgagor,  it  is  necessary  to 
make  the  books  reflect  the  fact  that  the  old  debt  has  been 
canceled  and  that  a  new  one,  having  a  longer  maturity,  has 
been  incurred. 

4.  Surrender  of  Securities.  If  the  consideration  has 
been  the  surrender,  by  the  creditor,  of  securities  pledged  to 
him  in  exchange  for  the  security  of  the  mortgage,  the  chang^e 
in  the  nature  of  the  liability  must  be  recorded  by  canceling 
the  pre-existing  debt  and  recording  the  new  one. 

Chattel  Mortgages 

Real  estate  mortgages  convey  title  to  real  property; 
chattel  mortgages  transfer  title  to  personal  property;  both 
do  so  with  a  clause  of  defeasance,  that  is  to  say,  with  a 
clause  to  the  effect  that,  if  the  giver  of  the  security  per- 
forms his  share  of  the  contract,  the  title  reverts  to  him.  It 
has  been  repeatedly  held  by  courts  of  law  that  the  passing  of 
the  title  under  both  kinds  of  mortgages  is  merely  a  legal 
fiction,  and  that  what  the  mortgagee  really  receives,  is  a 
lien  pure  and  simple. 

As  to  the  consideration  for  chattel  mortgages,  it  has  been 
claimed  that  any  consideration  which  will  support  an  or- 
dinary contract  will  also  support  a  chattel  mortgage. 

The  covenants  of  both  the  real  estate  mortgage  and  the 
chattel  mortgage,  if  legally  enforceable,  might  accumulate 
the  value  of  the  asset  of  the  mortgagee,  or  the  extent  of  the 
debt  of  the  mortgagor.  If,  for  instance,  one  of  the  covenants 
is  to  the  effect  that  the  mortgagor  is  to  pay  all  legal  fees 
and  all  other  costs,  trouble,  and  expenses,  the  notice  by  the 
mortgagee  of  the  amount  expended  by  him  mast  be  recorded 
by  the  mortgagor  as  an  increment  of  the  debt,  and  by  the 
mortgagee  as  an  increase  of  the  asset. 

The  main  accounting  difference  between  real  estate  and 


SECURED    DEBT  34^ 

chattel  mortgages  is  found  in  the  fact  that  the  terms  of  the 
former  are  usually  of  such  duration  as  to  make  the  debt  a 
capital  liability,  whereas  the  terms  of  the  latter,  if  stated,  are 
usually  short,  and,  if  not  stated,  make  the  instrument  pay- 
able on  demand. 

Interest  on  Mortgaged  Debt 

From  the  point  of  view  of  accounting,  there  is  nothing 
particularly  interesting  in  the  debt  incurred  for  interest  on 
mortgages,  except  that,  if  not  paid  when  due,  it  may  in  all 
propriety  be  added  to  the  principal  debt. 

Secured  Debt 

The  term  "secured  debt"  is  used  by  accountants  to  denote 
all  liabilities,  to  secure  which  an  asset  has  been  pledged  by 
transfer  to  the  creditor.    . 

The  word  "pledge"  is  used  here  in  its  strictly  legal  sense, 
as  indicating  the  physical  transfer  to  the  creditor  of  valuable 
property  of  the  debtor,  to  be  held  until  settlement  by  the 
pledgor,  who  retains  title  in  the  thing  pledged. 

Debts  may  be  secured  by  the  pledge  of  bonds,  stocks, 
mortgages  receivable,  warehouse  receipts,  or  by  the  pledge 
of  any  personal  property  or  evidence  of  the  possession  and 
ownership  of  such  property. 

The  pledging  of  bonds,  stocks,  or  other  personal  prop- 
erty as  security  for  debt,  leaves  the  borrower  in  legal  posses- 
sion of  the  pledge,  but  places  the  creditor  in  physical  posses- 
sion thereof.  True  to  the  principles  of  law,  the  theory  of 
accounts  requires  that  the  pledgor  record  his  liability  under 
the  loan,  in  the  amount  of  the  asset  received,  and  make  no 
record  whatsoever  in  the  account  containing  the  asset 
pledged  by  him  to  secure  a  more  liquid  one. 

We  have  already  discussed  at  length  the  nature  of  bonds 
and  stocks  as  assets  or  as  liabilities.  Nothing  further  need 
be  said  about  them  in  their  capacity  as  pledges.    It  may,  how- 


350    THE   THEORY   OF   THE   LIABILITY   ACCOUNTS 

ever,  be  interesting  to  touch  upon  warehouse  receipts,  which 
are  so  often  used  by  business  houses  as  security  for  advances 
from  financial  institutions. 

Warehouse  Receipts 

A  warehouse  receipt  is  an  acknowledgment  by  a  ware- 
houseman that  he  has  received  and  holds  in  store  for  the 
bailor  the  amount  and  description  of  goods  named  in  the 
receipt. 

At  common  law,  warehouse  receipts  were  not  negotiable, 
although  they  were  assignable ;  but  since  certain  states  have 
enacted  statutes  concerning  these  instruments,  it  must  be 
said  that  they  are  governed  by  the  laws  of  the  particular 
states  in  which  issued. 

The  Uniform  Warehouse  Receipts  Act  (Par.  516)  has 
this  to  say  about  this  type  of  commercial  paper :  "A  receipt 
in  which  it  is  stated  that  the  goods  received  will  be  delivered 
to  the  depositor  or  to  any  other  specified  person  is  a  non- 
negotiable  receipt.  A  receipt  in  which  it  is  stated  that  the 
goods  received  will  be  delivered  to  the  bearer,  or  to  the  order 
of  any  person  named  in  such  receipt,  is  a  negotiable  receipt." 

The  pledging  of  a  warehouse  receipt  as  security  for  a 
loan  is  made  valid  by  the  mere  delivery  of  the  receipt  with 
the  intention  to  create  a  pledge.  If  the  pledgor  fails  to 
pay  his  indebtedness  at  the  appointed  time,  the  pledgee  may 
sell  the  property  represented  by  the  receipt,  after  having 
notified  the  pledgor  of  his  intention  to  do  so. 

UNSECURED    DEBT 
Notes  and  Bills  Payable 

The  status  of  promissory  notes  payable  cannot  be  ascer- 
tained without  a  thorough  knowledge  of  the  law  of  com- 
mercial paper ;  the  same  is  true  of  the  liability  account  "Bills 
Payable." 


UNSECURED    DEBT  351 

It  is  untjuestionably  true  that  the  average  keeper  of  ac- 
counts, after  drawing  a  postdated  check,  will  generally  credit 
cash  and  debit  the  creditor's  account,  precisely  as  if  the 
check  bore  the  date  when  drawn.  Still,  under  the  doctrine 
of  the  laws  of  commercial  paper,  a  postdated  check  is  a 
negotiable  bill  of  exchange,  payable  on  demand  after  the 
day  of  its  date;  and  further,  the  acceptor  of  the  check  ac- 
cepts it  precisely  as  he  would  a  bill  of  exchange;  hence,  the 
recording  of  a  postdated  check  for  the  payment  of  a  liability 
fails  to  cancel  the  liability;  it  merely  transforms  it  into  an- 
other, and  the  entry  should  be : 
Creditor 

To  Bills  Payable 

As  has  been  said  before  when  treating  of  assets,  the  gen- 
eral term  "notes  and  bills"  should  be  kept  in  separate 
accounts. 

Bills  Payable 

The  signature  of  the  drawer  of  a  bill  of  exchange  is  of 
itself  a  guarantee  to  the  payee  that  the  drawee  has  sufficient 
funds  to  meet  the  bill ;  it  is  also  an  implied  guarantee  that 
the  drawee  will  accept  the  instrument  and  pay  it  at  its 
maturity,  or  that,  in  the  case  of  default  by  the  drawee,  the 
drawer  will  pay  the  bill. 

If,  then,  the  drawee  has  funds  of  the  drawer,  the  former 
must,  upon  acceptance  of  the  instrument,  debit  the  drawer 
and  credit  the  account  "Accepted  Bills  Payable" ;  the  drawer, 
on  the  other  hand,  must  credit  the  drawee  and  debit  the 
payee.  If,  in  contradistinction,  the  drawee  has  no  funds  of 
the  drawer,  the  latter  must  debit  the  payee  and  credit  the 
drawee,  whereas  the  drawee  must  debit  the  drawer  and 
record  the  liability  incurred  by  him  for  the  account  of  his 
correspondent 

If  the  drawee  refuses  to  accept  the  bill,  the  drawer  be- 
comes liable;  that  is  to  say,  instead  of  having  realized  an 


352    THE   THEORY    OF   THE   LIABILITY    ACCOUNTS 

asset  and  applied  it  to  the  liquidation  of  a  debt,  hef  has  merely 
changed  the  nature  of  his  indebtedness  towards  the  payee. 
Hence,  he  must  reverse  the  entry  previously  made  and  record 
the  change  in  the  nature  of  the  liability. 

The  liability  of  the  drawee,  under  the  terms  of  a  bill  of 
exchange,  begins  only  upon  his  acceptance  of  the  instru- 
ment, and  should  be  recorded  only  at  that  time,  whereas  the 
liability  of  the  drawer,  or  maker,  ceases  upon  acceptance  by 
the  drawee,  and  should  be  canceled  at  that  time,  there  re- 
maining only  a  contingent  liability. 

Memorandum  Checks 

Germane  to  the  subject  of  bills  of  exchange,  is  that  of 
memorandum  checks.  When  it  is  desired  to  acknowledge  a 
debt  in  a  formal  financial  way,  a  check  is  sometimes  drawn 
in  the  amount  of  the  debt,  bearing  the  date  of  maturity  of  the 
liability,  and  the  word  "Memorandum"  written  across  its 
face.  Such  a  check  is  not  intended  for  immediate  presenta- 
tion, and  is  in  fact  a  bill  of  exchange  payable  on  demand 
after  its  maturity.  Of  course,  if  the  check  is  not  postdated, 
the  fact  that  it  bears  the  word  "Memorandum"  does  not 
prejudice  the  right  of  the  payee  to  present  it  immediately. 

The  execution  of  a  postdated  memorandum  check  calls 
for  no  special  accounting  record  if  the  original  debt  has  been 
recorded  in  the  usual  manner  through  the  creditor's  account. 
In  the  contrary  case,  the  credit  may  be  given  to  the  account 
"Bills  Payable." 

Promissory  Notes  Payable 

While  the  liability  of  the  drawer  of  a  bill  of  exchange  is 
secondary,  that  of  the  maker  of  a  promissory  note  remains 
primary;  or,  what  is  more  to  the  point,  if  the  note  is  not 
negotiable,  the  nature  of  the  liability  of  the  maker  towards 
the  payee  has  not  changed  in  the  slightest  degree.  Conse- 
quently, the  transaction  in  virtue  of  which  a  non-negotiable 


UNSECURED    ETEBT 


353 


promissory  note  has  been  issued  to  a  creditor,  requires  no 
recording  if  the  maker  of  the  instrument  considers  only  its 
legal  status.  In  the  case  of  a  negotiable  instrument  it  is 
customary  to  cancel  the  original  debt  for  which  the  note  is 
issued,  and  to  record  the  new  debt  in  the  account  "Notes 
Payable." 


CHAPTER  XXX 

ACCOUNTS  PAYABLE— DIVIDENDS  PAYABLE 

Accounts  Payable  Records 

Theoretically,  the  term  "accounts  payable"  is  a  balance 
sheet  term.  When  found  in  that  financial  statement,  it  may 
include : 

1.  The  credit  balances  of  the  accounts  of  creditors 

2.  The  amount  of  expense  bills  received  at  the  end  of 

a  period,  and  not  paid  as  at  the  date  of  the  balance 
sheet 

3.  The  balances  due  to  officers  or  employees  of  the  con- 

cern on  credit  accounts  which  they  were  permitted 
to  accumulate  for  any  purpose  whatsoever 

4.  Unsettled  claims  against  the  concern  from  whatever 

sources  they  may  originate 

5.  Taxes,  rentals,  interest,  due  and  unpaid  at  the  time 

of  the  statement,  etc.,  etc. 

Inasmuch  as  the  purpose  of  a  balance  sheet  is  to  show 
the  financial  status  of  an  enterprise  at  some  given  date,  it 
does  not  particularly  matter  whether  or  not  unsecured  in- 
debtedness is  so  analyzed  as  to  show  its  sundry  elements. 
But  while  the  balance  sheet  may  be  permitted  to  speak  in 
general  terms,  the  books  of  account  must  be  in  a  position  to 
supply  at  all  times  the  most  minute  information  concerning 
financial  facts.  Hence,  the  general  ledger  should  not  be 
satisfied  to  gather  in  one  account  all  the  possibilities  of  un- 
secured accounts  or  claims  to  be  paid ;  it  should  express  every 

354 


DIVIDENDS    PAYABLE 


355 


component  individually.  It  ought  to  be  possible  to  obtAiii 
from  the  ledger  the  exact  significance  of  the  classes  of  in- 
debtedness which  have  been  incurred  during  the  accounting 
period  and  remain  unpaid  at  the  end. 

That  this  principle  of  ever-ready  analysis  constitutes  one 
of  the  vital  desiderata  of  business,  is  evidenced  by  the  care 
with  which  accountants  have  built  up  the  voucher  register, 
which  supports  in  admirable  detail  the  one  ledger  account 
expressive  of  all  outstanding  claims  and  accounts,  i.e., 
"Audited  Vouchers  Unpaid."  The  voucher  register,  it 
must  be  remembered,  does  not  intend  to  supplant  any  par- 
ticular book,  or  to  merge  two  or  more  books  into  one;  it 
merely  intends  to  analyze  for  the  general  ledger,  and  to 
present  in  ever-ready  and  concise  form  the  analysis  of,  the 
liability  account  "Accounts  Payable,"  or  "Audited  Vouchers 
Unpaid." 

The  ledger  account  "Audited  Vouchers  Unpaid"  is  not 
intended  to  contain  the  liability  for  salaries  and  wages  ac- 
crued and  unpaid  because  not  yet  payable ;  it  has  nothing  to 
do  with  accruals.  It  may,  however,  properly  contain  the  un- 
settled claims  for  salaries  and  wages  which,  having  been 
properly  audited  and  recorded  in  the  pay-roll  book  or  on  the 
departmental  salary  voucher  sheets,  have,  for  some  reason  or 
another,  remained  unpaid.  The  account  "Audited  Vouchers 
Unpaid"  is  made  to  reflect  these  facts  by  a  periodical  journal 
entry  debiting  the  account  "Salaries  and  Wages  Accrued," 
and  crediting  the  matured  liability  account. 

Dividends  Declared  and  Unpaid 

"A  dividend  is  that  portion  of  the  profits  and  surplus 
funds  of  the  corporation  which  has  been  actually  set  apart  by 
a  resolution  of  the  board  of  directors,  or  by  the  shareholders 
at  a  corporate  meeting,  for  distribution  among  the  share- 
holders according  to  their  respective  interests,  in  such  a 
sense  as  to  become  segregated  from  the  property  of  the  cor- 


356 


THE   THEORY    OF   THE    LIABILITY    ACCOUNTS 


poration,  and  to  become  the  property  of  the  stockholders  dis- 
tributively."^ 

It  must  be  carefully  noted  that  only  dividends  declared 
make  the  stockholders  individual  creditors  of  the  corpora- 
tion, and  that  holders  of  preferred  and  guaranteed  shares  of 
stock  are  not  de  facto  creditors  in  the  event  that  dividends 
which  they  had  the  right  to  expect,  were  not  declared  by  the 
directors. 

It  has  been  stated  repeatedly  that  dividends  declared  and 
unpaid  constitute  a  trust  fund  in  the  hands  of  the  directors 
for  the  benefit  of  the  stockholders,  and  cannot  be  disposed 
of  otherwise  than  as  intended,  without  the  absolute  and 
formal  consent  of  those  entitled  thereto.  On  the  other  hand, 
it  is  true  that  in  a  famous  Alabama  case^  it  was  held  that, 
in  the  event  of  insolvency  of  a  corporation,  dividends  unpaid 
became  an  asset  of  the  corporation  to  be  applied  for  the 
benefit  of  outside  creditors;  but  such  a  legal  doctrine  is  so 
entirely  subversive  of  the  care  with  which  laws  in  general 
have  guarded  the  interests  of  stockholders,  that  it  may  be 
challenged  without  fear  or  scruples.  Indeed,  in  the  State  of 
New  York  it  has  been  held  that  the  receiver  of  a  corpora- 
tion whose  books  show  dividends  declared  and  unpaid,  can- 
not regard  these  dividends  as  a  common  debt,  but  must  con- 
sider them  as  trust  funds  vested  with  a  lien  in  favor  of  the 
stockholders.^ 

The  sanctity  of  the  dividend  as  a  true,  just,  and  uncan- 
celable  debt  of  the  corporation  has  been  proclaimed  em- 
phatically in  North  Carolina  where  the  State  attempted  in 
vain  to  appropriate  unpaid  dividends  of  the  North  Carolina 
Railroad  Company  for  the  benefit  of  the  State  University. 

When  dividends  have  been  declared,  and  made  payable 
at  some  future  time,  they  can  be  rescinded  only  in  the  event 
that  no  knowledge  of  the  declaration  has  transpired  outside 

»  Cyclopedia  of  Law  and  Procedure,  Vol.  X,  546. 

*  Curry  v.  Woodward,  44  Ala.  305. 

»  Matter  of  Le  Blanc,  4  Abb.  N.  C.  (N.Y.)  221. 


DIVIDENDS    PAYABLE 


357 


of  the  board  room.  This,  however,  does  not  hold  good  if 
it  is  found  that,  instead  of  being  declared  out  of  the  profits, 
dividends  have  actually  been  declared  out  of  capital. 

If  the  dividends  have  been  declared  and  paid  illegally,  it 
is  also  possible  for  the  corporation  to  recover  them  from  the 
stockholders  if  the  latter  knew  that  they  were  actually  re- 
ceiving part  of  their  capital  to  the  prejudice  of  creditors  of 
the  corporation ;  but  it  is  not  possible  to  recover  such  divi- 
dends in  the  case  where  the  stockholders  were  ignorant  of 
conditions  and  received  the  dividends  in  good  faith. ^ 

What  has  been  said  in  the  foregoing  applies  only  to  the 
dividends  declared  by  a  going  concern.  The  dividends  of  a 
liquidating  concern  are  nothing  more  than  the  pro  rata  divi- 
sion of  whatever  is  left  of  the  assets  after  all  the  claims  have 
been  paid. 

The  law  of  New  York,  which  in  this  respect  is  typical 
of  the  laws  of  the  other  states,  provides  that  dividends  can 
only  be  declared  out  of  surplus  profits  earned.  In  a  Califor- 
nia case  it  was  held  that  dividends  cannot  be  declared  out  of 
earnings  which  represent  interest  accrued  and  not  as  yet 
receivable,  even  though  it  is  certain  that  such  interest  will 
be  received.^  But  it  would  seem  that  such  a  ruling  is  at 
loggerheads  with  the  principles  of  accounting  and  with 
the  rulings  of  the  Internal  Revenue  Department  of  the 
Federal  Government  as  to  what  constitutes  income. 

Profits  Available  for  Dividends 

What  constitutes  "profits  and  surplus"  available  for  the 
declaration  of  dividends,  will  always  remain  one  of  the  in- 
teresting topics  of  the  science  of  accounting.  Courts  of  law 
have  ruled  that  it  is  perfectly  proper  to  declare  dividends 
out  of  profits  inflated  by  the  increase  of  the  market  value  of 
assets  unsold.     In  a  decision  by  Justice  Greenbaum^  the 

»  McDonald  v.  Williams,  174  U.  S.  397 ;  19  S.  Ct.  743 ;  43  L.  Ed.  1002. 

"  People  V.  San  Francisco  Sav.  Union,  72  Gal.  199;  13  Pac.  498. 

*  N.  Y.  Supreme  Ct. ;  Reported  in  N.  Y.  Law  Journal,  April  2,  1914. 


358 


THE  THEORY   OF   THE  LIABILITY   ACCOUNTS 


court  said:  "A  corporation  has  a  very  wide  discretion  in 
determining  when  a  dividend  shall  be  made.  There  might 
be  a  difference  of  opinion  in  a  given  case  as  to  the  wisdom 
of  accumulating  a  large  surplus  which  otherwise  would  be 
applicable  to  the  payment  of  dividends,  but  that  would  not  be 
a  subject  for  legal  interference  where  the  discretion  is  fairly 
exercised.  If  the  defendant  corporation  has  the  right  to 
accumulate  a  surplus,  it  has  the  right  to  invest  the  surplus  in 
securities,  and  if  the  securities  appreciate  in  value,  there  is 
no  reason  why  the  profits  arising  from  the  investment  should 
not  be  regarded  as  the  profits  of  the  business  of  the  corpora- 
tion." 

The  language  of  the  courts  is  quite  clear  as  to  the  ulti- 
mate disposition  of  increased  value  of  securities  acquired  out 
of  surplus.  It  remains  to  be  seen,  however,  whether  or  not 
it  is  proper  to  pay  dividends  out  of  "profits"  obtained  by 
adding  to  capital  assets  of  a  physical  nature,  acquired  to  be 
used  for  the  operating  purposes  of  the  business,  favorable 
market  fluctuations  which  cannot  be  realized  in  cash,  since 
the  assets  are  not  for  sale,  nay,  cannot  be  sold  without  bring- 
ing operations  to  a  stop  or  to  an  end. 

It  is  quite  conceivable  that,  in  order  to  swell  the  surplus 
to  a  figure  which  will  secure  for  it  a  respectable  appearance 
after  the  declaration  of  dividends  out  of  profits  actually 
realized,  favorable  fluctuations  in  the  market  value  of  fixed 
assets  acquired  out  of  capital  contributions,  may  be  con- 
sidered. We  say  that  it  is  conceivable,  because  of  the  well- 
known  tendency  of  investors  to  consider  the  surplus  of  cor- 
porations as  the  most  attractive  item  on  their  balance  sheet, 
irrespective  of  the  actuality  and  accuracy  of  the  assets,  the 
supposed  value  of  which  is  exhibited  by  the  financial  state- 
ment. But  to  declare  and  pay  a  cash  dividend  out  of  such 
fluctuations  when  it  is  possible  that  at  the  time  the  assets  are 
sold  their  value  will  be  considerably  less  than  is  shown  by 
the  books,  appears  to  be  nothing  more  than  paying  dividends 


DIVIDENDS    PAYABLE 


359 


out  of  anticipated  profits.  This  is  said  with  full  knowledge 
of  the  fact  that  decisions  may  be  found  upholding  the  legality 
of  such  dividends. 

If  it  is  really  desired  to  give  to  the  stockholders  the 
benefit  of  increased  market  value  of  capital  assets,  it  would 
be  infinitely  better  to  declare  and  pay  a  stock  dividend.  In 
that  case,  if  profits  eventually  turned  out  to  be  losses,  the 
deficiency  in  assets  to  be  distributed  could  be  charged  to  the 
capital  stock  issued  under  the  form  of  dividends. 

Dividends  from  Income — from  Increased  Valuations 

That  there  is  a  marked  distinction  between  dividends  de- 
clared out  of  income  and  profits  obtained  from  the  actual 
financial  transactions  of  a  concern  examined  from  the  view- 
point of  operations,  and  dividends  declared  out  of  profits 
obtained  from  the  increment  of  invested  values,  is  evidenced 
by  the  fact  that  in  differentiating  between  "corpus"  and 
"income,"  in  matters  affecting  life-tenants  and  remainder- 
men, courts  have  generally  decided  that: 

1.  Dividends,  whether  paid  in  cash  or  in  stock,  declared 

out  of  income  and  profits,  are  income  and  belong 
to  the  life-tenant. 

2.  Dividends,  whether  jfaid  in  cash  or  in  stock,  declared 

out  of  profits  due  to  increased  valuations,  are 
principal  and  belong  to  the  remaindermen. 

As  an  accounting  proposition,  proper  differentiation 
should  be  had  between  the  components  of  the  surplus  before 
declaration  of  dividends,  in  every  instance  where  the  capital 
stock  of  the  concern  is  composed  of  preferred  stock  receiving 
a  stated  amount  of  dividends,  and  of  common  stock  receiv- 
ing, if  advisable,  the  balance  of  the  profits.  If  the  profits 
are  made  up  of  operating  profits  on  the  one  hand,  and  of 
profits  due  to  the  sale  of  invested  capital  on  the  other  hand, 
accounting  principles  would  seem  to  require  that,  when  about 


360    THE  THEORY   OF  THE   LIABILITY    ACCOUNTS 

to  pay  dividends,  the  surplus  be  divided  into  two  distinct 
parts: 

1.  The  portion  which  represents  operating  earnings 

2.  The  portion  which  represents  increments  of  capital 

and  that,  the  preferred  stock  having  received  its  portion  of 
the  operating  profits,  and  the  common  stock  the  balance,  the 
surplus  component  representing  increments  of  capital  be  dis- 
tributed pro  rata  to  both  classes  of  stock  in  the  ratio  that 
the  preferred  stock  bears  to  the  common  stock. 

This  is  precisely  the  view  taken  by  the  legal  and  account- 
ing advisers  of  the  Equitable  Life  Assurance  Society  of  the 
United  States  in  the  matter  of  an  extra  dividend  of  $80,- 
000,000  declared  in  January,  19 14,  by  the  Union  Pacific 
Railroad  Company,  whose  preferred  stock  was  held  in  part 
by  the  Life  Assurance  Society.  The  surplus  out  of  which 
this  dividend  was  declared,  was  made  up  in  part  of  approxi- 
mately $59,000,000  representing  profits  on  sales  of  securi- 
ties of  affiliated  and  controlled  companies,  and  approximately 
$15,000,000  gained  in  the  conversion  of  convertible  bonds 
into  common  stock  on  the  basis  of  $175  of  bonds  for  each 
$100  of  stock.  In  deciding  against  the  Assurance  Society, 
Justice  Greenbaum  of  the  Supreme  Court  appears  to  have 
been  influenced : 

1.  By  the  terms  of  the  preferred  stock  issue  which 

stated :  "Such  preferred  stock  shall  be  entitled  in 
preference  and  priority  over  the  common  stock  to 
dividends  in  each  and  every  fiscal  year,  at  such 
rate,  not  exceeding  4%  per  annum,  payable  out  of 
net  profits,  as  shall  be  declared  by  the  board  of 
directors.  Such  dividends  are  to  be  non-cumula- 
tive and  the  preferred  stock  is  entitled  to  no  other 
or  further  share  of  its  profits." 

2.  By  the  decision  in  the  case  of  William  v.  Western 

Union  Tel.  Co.  (93  N.  Y.  162,  168)  to  the  effect 


DIVIDENDS     PAYABLE  361 

that  the  capital  stock  of  a  corporation  is  the 
capital  or  property  contributed  by  the  stockholders 
to  the  extent  required  by  its  charter,  and  that 
"whatever  property  it  has  up  to  that  limit  must 
be  regarded  as  its  capital  stock"  and  that  any 
amount  of  property  over  that  limit  is  surplus 
profits. 

Of  course  the  ruling  of  the  learned  justice  is  the  law  in 
the  case  and  will  remain  the  law  until  reversed;  but  ac- 
countants may  still  be  found  who  believe  that  the  contention 
of  the  Equitable  Life  Assurance  Society  was  remarkably  true 
to  principles  of  accounting,  and  exhibited  the  shortcoriiings 
of  preferred  stock  for  the  benefit  of  future  investors. 

Dividends  declared  on  capital  stock  belong  to  the  stock- 
holders of  record  on  the  day  the  corporate  books  are  closed, 
and  the  right  to  them  passes  to  subsequent  purchasers  of  the 
stock  only  upon  mutual  agreement  between  the  interested 
parties.  This  is  particularly  interesting  because  it  is  not  in- 
frequent to  find  among  business  men  the  belief  that  "option" 
sales  of  shares  of  stock  convey  to  the  buyer  of  the  option  the 
right  to  dividends  declared  on  the  shares  between  the  initial 
and  the  closing  date  of  the  option. 

Stock  Dividends 

Stock  dividends  may  be  declared  in  lieu  of  cash  dividends, 
or  as  a  result  of  the  receipt  of  property  by  donation,  gift, 
etc.,  or  under  the  form  of  increments  in  value  over  the 
amount  paid  therefor.  In  the  first  instance  the  term  "stock 
dividend"  is  a  misnomer;  it  should  be  "dividends  paid  in 
stock." 

Accounting  Treatment  of  Dividends 

In  many  European  countries  dividends  are  declared  by 
the  stockholders  at  their  annual  meeting.  Having  accepted 
the  financial  statements  as  submitted  by  the  directors,  they 


362    THE   THEORY   OF   THE   LIABILITY   ACCOUNTS 

vote  that  a  certain  portion  of  the  annual  profits  be  set  aside 
for  reserves,  that  another  portion  be  distributed  to  those  en- 
titled thereto,  and  that  the  remainder,  if  any,  be  transferred 
to  surplus.  If  there  are  not  sufficient  profits  from  the  year's 
operations  for  the  declaration  of  the  desired  dividend,  the 
surplus  is  drawn  upon,  the  required  amount  being  sent  to 
the  profit  and  loss,  out  of  which  all  regular  dividends  are 
paid.    Extra  dividends  are  paid  out  of  surplus. 

It  is  safe  to  say  that  in  America  the  majority  of  the 
corporations  send  the  annual  or  the  semiannual  balance  of 
net  unappropriated  profits  to  the  surplus,  and  declare  divi- 
dends out  of  that  account.  The  journal  entry  giving  ex- 
pression on  the  financial  books  to  the  declaration  of  divi- 
dends is  : 

Surplus  (or  Profit  and  Loss,  if  the 

occasion   arises) $...... 

To  Dividends  Payable  No $ 

It  is  customary  to  number  the  dividends,  giving  a  differ- 
ent series  of  numbers  to  the  different  classes  of  stock. 

Unpaid  portions  of  dividends  declared  must  remain  a 
liability  of  the  corporation  until  claimed;  and  if  it  has  be- 
come certain  that  they  never  will  be  claimed,  they  can  onlv 
return  to  surplus  by  decision  of  the  board  of  directors. 


CHAPTER  XXXI 

ACCRUED    LIABILITIES— DEFERRED 
CREDIT    ITEMS 

Accrued  Liabilities 

Liabilities  accrued,  but  not  due,  are  recorded  in  order 
that  the  income  charges  which  they  represent  may  be  made 
to  apply  to  the  period  in  which  they  originated.  The  ad- 
visability of  entering  such  charges  at  the  end  of  a  period  is 
largely  dependent  on  the  requirements  of  the  financial  state- 
ments to  be  obtained  at  the  time.  If  a  true  financial  condi- 
tion is  to  be  exhibited,  all  accrued  income  charges  must  be 
included  in  the  statements,  as  well  as  all  accrued  income 
benefits,  or  credits 

What  the  accrued  liabilities  will  contain,  depends  es- 
sentially upon  the  business  conducted  and  upon  the  type 
of  organization.  The  inclusion  of  taxes  in  this  group  of 
liabilities  is  due  to  the  fact  that,  unless  the  theory  of  ac- 
cruals is  accepted  and  applied  to  the  accounting  of  an  en- 
terprise, taxes  are  recorded  when  paid,  and  do  not  appear 
as  a  liability  at  any  time. 

The  date  at  which  the  liability  for  taxes  arises,  depends 
of  necessity  upon  the  provisions  of  the  statutes  regulating 
the  imposition  of  taxes  by  the  different  subdivisions  of  the 
body  politic.  Generally  speaking,  however,  an  individual 
is  liable  for  taxes  on  whatever  taxable  property  he  pos- 
sesses on  the  day  fixed  for  the  completion  of  the  tax  list, 
and,  while  agreements  between  parties  transferring  the  lia- 
bility for  taxes  from  one  to  the  other  may  be  valid  as  be- 

363 


364 


THE   THEORY   OF   THE    LIABILITY    ACCOUNTS 


tween  them,  such  agreements  do  not  relieve  the  original 
party  of  his  liability  for  its  payment. 

Taxes,  Licenses,  Assessments,  and  Fees 

Taxes  are  contributions  imposed  by  the  body  politic 
upon  its  citizens,  for  its  support  and  their  protection. 

License  fees  are  taxes  imposed  on  the  right  to  conduct 
a  certain  business.  In  most  states  they  are  imposed  on 
such  businesses  as  require  special  inspection,  control,  or 
regulation. 

Assessments  are  charges  made  against  property  owners 
benefited  by  improvements  made  to  public  property,  to 
defray  the  cost  of  the  said  improvements.  Thus  assess- 
ments partake  of  the  nature  of  a  consideration  for  the  en- 
hanced value  of  the  property  by  reason  of  the  impro\e- 
ments  made. 

Fees  include  all  amounts  paid  to  public  officers  for 
services  rendered. 

Classification  of  Taxes 

Taxes  are  divided  into  direct  and  indirect.  Direct  taxes 
are  imposed  upon  the  individual  with  the  intention  that  he 
shall  pay  them  and  bear  the  burden  of  them  himself.  In- 
direct taxes  are  those  imposed  upon  property  in  such  wise 
that  they  can  be  added  to  the  price  and  so  passed  on  to 
somebody  else.  More  specifically,  taxes  may  be  classified 
as: 

1.  Federal  Taxes 

2.  State  Taxes 

3.  Municipal  Taxes 

Taxes  are  further  subdivided  as: 

1.  Business  and  Occupation  Taxes 

2.  Property  Taxes 

3.  Excise  Taxes 

4.  Inheritance  Taxes 


ACCRUED    LIABILITIES 


365 


1.  Business  Taxes 

The  term  "business  taxes"  includes  all  taxes  which  can- 
not be  strictly  construed  as  taxes  on  property,  excise  taxes, 
or  inheritance  taxes ;  they  are,  for  instance : 

a.  Taxes   upon   the   premium    receipts    of    insurance 

companies 

b.  Taxes  upon  the  gross  receipts  of  railroad  companies 

c.  Taxes  on  savings  banks  according  to  their  deposits 

"Occupation  taxes"  are  in  the  nature  of  licenses  to  con- 
duct business,  rather  than  taxation  in  a  strict  sense  of  the 
term. 

2.  Property  Taxes 

Property  taxes  are  subdivided  into : 

a.  Taxes  on  real  property  and  interest  thereon 

b.  Taxes  on  personal  property 

a.  Taxable  real  property  includes,  generally  speaking, 
whatever  the  individual  state  laws  have  classified  as  real, 
such  as  land  and  buildings  and  their  appurtenances  and  im- 
provements; machinery  and  fixtures  which  are  attached  to 
the  buildings  in  such  a  manner  as  to  be  part  of  them  under 
the  meaning  of  the  law ;  mines,  minerals,  and  even  mining 
rights;  riparian  and  water  rights;  bridges  and  wharves. 

b.  Taxable  personal  property  includes :  money  in  the 
possession  of  the  individual,  or  receivable  by  him  at  the 
time  of  the  assessment;  traders'  and  manufacturers'  stock 
in  trade ;  boats  and  vessels ;  loans  and  investments  of  money ; 
debts  due  to  residents  by  non-residents;  annuities;  fran- 
chises, etc. 

3.  Excise  Taxes 

These  taxes  are  levied  on  particular  classes  of  goods, 
or  commodities;  the  term  commodities  has  been  said  by 
eminent  jurists  to  include  corporate  franchises,  transfers 


366 


THE    THEORY    OF    THE   LIABILITY    ACCOUNTS 


of  shares  of  stock,  and  the  giving  of  trading  stamps  in 
connection  with  a  sale  of  merchandise,  giving  right  to 
goods  other  than  the  goods  sold. 

4.  Inheritance  Taxes 

These  taxes  are  imposed  upon  the  privilege  of  acquiring 
property  by  inheritance,  legacy,  or  succession;  they  are 
levied  in  accordance  with  the  provisions  of  the  laws  of  the 
individual  states.  The  rate  of  the  tax  and  the  particular 
properties  which  will  be  deemed  taxable,  are  also  matters 
of  state  legislation. 

Deferred  Credit  Items 

To  the  average  concern,  the  items  included  in  this  class 
of  financial  facts  are  not  liabilities;  they  are  merely  (i) 
benefits  received  during  a  certain  period  and  applicable  to 
a  subsequent  one,  as  for  instance : 

a.  Unextinguished  discounts  on  securities  acquired 

b.  Unextinguished  premiums  on  securities  issued 

c.  Unearned  portion  of  fees  received  in  advance  of 

the  rendering  of  services 

or  (2)  aggregations  of  credits  measuring  the  amount  of 
cash  receipts  for  the  distribution  of  which  sufficient  in- 
formation is  lacking. 

It  requires  no  great  effort  of  imagination  to  realize 
that: 

I.  Discounts  obtained  on  securities  purchased  or  pre- 
miums realized  on  securities  issued  could  have 
been  applied  to  the  profits  of  the  period  in  which 
the  purchase  took  place,  and  that  it  is  only  the 
desire  to  make  a  series  of  periods  receive  the 
benefit  of  the  gain,  which  indicates  the  deferring 
of  the  application. 


DEFERRED    CREDIT    ITEMS 


367 


2.  Unearned  portions  of  fees  received  in  advance  of 

the  rendering  of  services,  while,  no  doubt,  giving 
rise  to  a  liability  for  work  which  may,  or  may 
not,  entail  expense,  do  not  represent  a  financial 
liability  as  we  understand  the  term.  Here,  again, 
it  is  only  the  desire  of  being  conservative  and 
true  to  accounting  principles  which  has  demanded 
that  the  application  of  the  fees  to  the  income  be 
deferred  until  such  time  as  the  work  is  done. 

3.  The  lack  of  suflScient  knowledge  to  properly  credit 

the  account  which  brought  in  cash,  does  not  give 
rise  to  a  liability,  but  merely  defers  the  time  when 
the  name  of  the  outgoing  value  will  be  known. 

The  rulings  of  the  Interstate  Commerce  Commission 
have  greatly  extended  the  meaning  of  the  term  "deferred 
credit  items"  so  far,  at  least,  as  public  service  corporations 
are  concerned.  This  class  of  facts  has  been  made  to  in- 
clude, not  only  benefits  applicable  to  subsequent  periods, 
unearned  portions  of  income,  and  credit  balances  of  sus- 
pense accounts,  but,  as  well,  operating  reserves,  and  lia- 
bilities on  account  of  provident,  pension,  savings,  relief,  and 
hospital  funds,  whether  contributed  by  employees,  or  by  the 
company,  or  by  both,  wherever  such  funds  are  managed  by 
trustees  for  the  company. 

While,  at  first  glance,  it  may  appear  odd  to  include 
operating  reserves  among  deferred  credit  items,  it  will  be 
seen,  when  the  nature  of  such  reserves  is  investigated,  that 
the  only  thing  which  may  happen  to  them  is  to  be  paid  out 
when  the  loss  for  which  they  provide  has  materialized.  And 
since  the  entry  giving  expression  to  the  payment  of  the 
reserve  will  be: 

Dr.     Reserve        —        Cr.     Cash 

it  must  be  readily  seen  that  what  is  actually  deferred  is  the 
time  when  cash  will  actually  go  out  to  pay  the  loss. 


368 


THE   THEORY    OF    THE   LIABILITY    ACCOUNTS 


Operating  reserves  are  created  by  charging  operations 
for  overcharges  to  passengers  or  shippers,  and  for  injuries 
and  claims  of  similar  nature,  which,  while  as  yet  not  posi- 
tively determinable,  are  bound  to  occur  in  an  amount  which 
experience  has  established,  within  a  series  of  periods.  The 
reason  for  spreading  the  losses  with  some  sort  of  equality 
over  a  series  of  periods  instead  of  taking  cognizance  of 
them  only  when  they  materialize,  is  to  be  found  in  the  ac- 
counting conviction  that  unless  this  is  done,  comparisons 
between  the  individual  periods  of  a  series  will  be  unfair.  It 
is  for  the  very  same  reason  that  all  accruals  are  so  often 
recorded  monthly. 

The  reason  for  the  inclusion  of  the  liability  for  pension, 
hospital  benefit,  and  other  similar  funds  is  to  be  found  else- 
where.   The  Interstate  Commerce  Commission  has  so  classi- 
fied the  balance  sheet  of  public  service  corporations  engaged 
in  the  interstate  trafific  that  it  is  possible  to  oppose : 
Capital      Assets      to      Capital      Liabilities 
Working  Assets      to      Working  Liabilities 
Accrued    Assets      to      Accrued    Liabilities 

Any  asset  or  liability  which  does  not  fit  this  classifica- 
tion is  of  practically  no  importance  so  far  as  the  operations 
of  the  property  are  concerned ;  the  assets  represent  nothing 
available  for  current  purposes ;  the  liabilities  represent  noth- 
ing which  has  to  be  met  for  current  purposes.  On  the  other 
hand,  there  is  an  item,  "Hospital  Fund,"  the  application  of 
which  is  deferred,  while  opposed  to  it  there  is  a  liability  the 
payment  of  which,  out  of  a  fund  with  a  deferred  applica- 
tion, is  postponed  until  the  claim  is  made. 


CHAPTER  XXXII 

RESERVES   AND    SURPLUS— PROPRIETORSHIP 
ACCOUNTS 

RESERVES  AND  SURPLUS 

Distinction  Between  Reserves  and  Surplus 

Reserves  and  surplus  not  appropriated,  together  measure 
the  profits  made  by  the  corporate  enterprise  and  as  yet 
undistributed.  As  such  they  constitute  the  increments  of 
its  capital  not  represented  by  shares  of  stock,  and  not  ex- 
pressible in  shares  of  stock  except  through  the  declaration 
of  a  stock  dividend. 

The  only  real  difference  between  reserves  and  surplus  is 
that  the  former  are  that  part  of  the  surplus  earnings  which 
has  been  set  aside  to  provide  for  losses  which  may  or  may 
not  materialize;  whereas  the  latter  is  that  part  of  the  sur- 
plus earnings  which  has  been  allowed  to  accumulate  for  dis- 
tribution among  the  stockholders  in  the  form  of  dividends, 
or  for  such  other  disposition  as  may  seem  desirable. 

The  foregoing  applies  neither  to  operating  reserves  nor 
to  reserves  for  depreciation  created  by  charges  to  cost  of 
operations  or  to  cost  of  goods  manufactured ;  nor  again,  to 
secret  reserves.  Still,  it  might  be,  and  has  been  argued  that 
by  reducing  the  profit  through  charges  to  income,  these  re- 
serves come  out  of  surplus  just  as  effectively  as  if  they  had 
been  appropriated  out  of  it.  The  truth  or  fallacy  of  this 
argument  will  becom.e  apparent  when  we  have  classified  re- 
serves and  analyzed  the  different  classes. 

369 


370    THE   THEORY   OF   THE   LIABILITY   ACCOUNTS 

Classification  of  Reserves 

Reserves  are  classified  as  follows: 

1.  Reserves  for  Depreciation.  Reserves  representing 
actual  losses  of  capital  through  operations,  charged  to  opera- 
tions or  to  manufacturing  cost  of  goods,  and  temporarily- 
withheld  from  the  asset  account  which  they  would  reduce 
if  applied  to  it. 

2.  Operating  Reserves.  Reserves  representing  charges 
to  operations  for  losses  which  have  not  yet  materialized  but 
will  positively  materialize. 

3.  Reserves  for  Surplus  Contingencies.  Reserves  repre- 
senting appropriations  of  surplus  for  losses  that  may  or  may 
not  materialize ;  such  reserves  are : 

a.  Invested  in  a  special  fund,  or 

b.  Not  specifically  invested,  but  contained  in  the  general 

fund  constituting  the  gross  assets. 

4.  Reserves  for  Redemption  of  Debt.  Reserves  repre- 
senting appropriations  of  profits,  intended  to  reduce  the 
amount  of  profits  available  for  distribution,  in  order  that 
the  amount  so  appropriated  may  be  compelled  to  remain  in- 
vested in  the  business  until  it  is  time  to  apply  it  to  the  re- 
demption of  debts.    These  reserves  may  be : 

a.  Specifically  invested  in  properly  earmarked  redemp- 

tion funds,  or 

b.  Not  specifically  invested. 

5.  Secret  Reserves.    Created  by: 

a.  Reducing  the  cost  or  book  value  of  certain  assets 

beyond  the  limits  of  the  probable  or  the  possible, 
or 

b.  Reducing  both  assets  and  profits  by  deducting  from 

the  cost  of  investments  the  income  which  they 
produce,  or 


RESERVES    AND    SURPLUS 


371 


c.  Applying  specific  or  general  contingency  reserves  to 
the  reduction  of  assets  with  which  they  are  not 
related. 
6.  Reserves  for  Exhaustion  of  Physical  Assets. 

Before  proceeding  further,  it  must  be  understood  that  the 
fact  that  an  account  is  called  "Reserve"  does  not  necessarily 
give  it  the  right  to  masquerade  under  that  title.  The  lia- 
bility recorded  for  taxes  accrued  can  no  more  be  called  a 
"reserve  for  taxes"  than  the  credit  offsetting  a  debit  to  an 
asset  for  increase  of  market  value  can  be  called  a  "reserve 
for  appreciation"  of  that  asset.  Nor  can  the  term  be  ap- 
plied to  a  deferred  credit  item  such  as  "unearned  consulting 
fees"  or  "unearned  title  fees." 

Having  classified  reserves,  each  class  must  be  analyzed, 
and  both  its  purpose  and  the  principles  which  is  applies  be 
ascertained. 

I.  Reserves  for  Depreciation 

Depreciation  is  composed  of  two  distinct  elements : 

a.  The  irreparable  loss  suffered  by  the  physical  unit 

through : 

( 1 )  Wear  and  tear  caused  by  operations 

(2)  Accidents 

(3)  Efflux  of  time 

(4)  Mere  exposure  to  the  elements 

b.  Obsolescence  of  the  type 

Whenever,  through  operation  or  accidental  causes,  a 
physical  unit  has  sustained  a  loss  of  efficiency  incapable  of 
being  restored  by  adequate  repairs,  there  is  supposed  to  re- 
main an  element  of  loss  which,  intangible  as  it  may  be,  has 
partially  consumed  the  capital  invested  in  the  unit;  and  as 
years  go  by,  the  succession  of  injuries  to  the  unit  reduce  it 
to  a  level  of  efficiency  so  low  as  to  make  the  asset  of  very 
little  value  from  a  practical  standpoint.    Thus,  elements  i, 


372    THE   THEORY   OF   THE   LIABILITY   ACCOUNTS 

2,  and  3  are  so  closely  related,  and  so  undeniably  associated 
with  operations,  that  it  has  been  deemed  quite  proper  to 
charge  the  depreciation  loss  which  they  indicate,  to  the  cost 
of  the  goods  manufactured,  or,  if  the  concern  is  not  manu- 
facturing, to  the  cost  of  conducting  the  enterprise. 

As  to  the  loss  due  to  exposure  to  the  elements,  it  may 
properly  be  argued  that  it  has  little,  if  anything,  to  do  with 
operations.  It  is,  besides,  so  difficult  to  estimate  properly  the 
loss  sustained,  that  it  would  seem  impossible  to  provide  for 
it  otherwise  than  by  appHcation  of  surplus,  subject  to  adjust- 
ments whenever  the  exact  truth  becomes  known. 

Obsolescence  of  type  represents  a  loss  only  when  known. 
Provision  for  this  loss  far  ahead  of  its  materialization  is 
one  of  the  many  precautions  dictated  by  conservatism,  which 
must  be  reckoned  with.  But  it  is  a  complete  denial  of  its 
purpose,  to  treat  it  indifferently,  and  sink  it,  merged  with 
other  elements  of  depreciation,  in  the  cost  of  operations.  If 
there  is  ever  a  good  reason  for  creating  a  specific  re- 
serve out  of  net  profits,  that  reason  is  presented  by  the 
possible  obsolescence  of  physical  units.  It  may  be  feared 
that  a  specially  made  machine  will  be  rendered  useless  within 
a  year  or  two  or  five  years,  by  the  invention  of  a  better  and 
more  economical  machine ;  but  the  expected  loss  may  never 
come,  or  may  be  postponed  for  many  years.  Hence,  logic 
would  indicate  a  special  treatment  for  a  special  condition. 

It  has,  unhappily,  become  the  usual  practice  to  consider 
the  term  "depreciation"  as  a  convenient  invention  for  as- 
similating antagonistic  factors ;  charges  made  to  operations 
under  the  title  of  "depreciation"  often  contain,  if  the  truth 
were  known,  provisions  for  unknown  quantities,  the  ulti- 
mate result  being  the  perversion  of  accounting  truth.  The 
main  trouble  with  such  unscientific  accounting  is  that  it 
works  at  cross  purposes  with  the  legitimate,  although  idealis- 
tic, aspirations  of  cost  finding.  It  denies  that  an  accounting 
statement  of  facts  should  be  truly  analytical,  and  should  at 


RESERVES    AND    SURPLUS 


373 


all  times  "split  hairs,"  if  necessary,  in  order  that  conclusions 
to  be  made  from  figures  submitted,  may  be  minutely  ac- 
curate instead  of  superficially  just. 

Coming  back  to  accounting  principles,  if  depreciation,  in 
the  accepted  sense  of  the  term  today,  is  charged  to  cost  of 
operations,  it  cannot  be  denied  that  it  represents  a  genuine 
loss  through  such  operations.  Hence,  the  creation  of  a  re- 
serve for  this  loss  is  tantamount  to  merely  deferring  the 
time  when  the  loss  will  be  credited  to  the  asset  which  has 
sustained  it.  As  a  consequence,  a  reserve  for  depreciation 
created  in  this  fashion  is  not,  and  cannot  be  said  to  be,  ap- 
propriated surplus;  it  cannot  be  shown  on  the  liability  side 
of  the  balance  sheet,  but  must  be  deducted  from  the  asset  in 
order  that  the  true  remainder  value  of  the  asset  may  be 
stated.  We  will  discuss  later  the  different  methods  of  pro- 
viding for  depreciation. 

2.  Operating  Reserves 

Operating  reserves  are  not  appropriations  of  surplus; 
they  measure  the  amount  of  all  additional  cost  of  operations 
which,  while  not  necessarily  incurred  at  the  present  time, 
will  positively  be  incurred  if  past  experience  counts  for  any- 
thing; they  represent  cost  incurred  and  unpaid,  and  the 
only  connection  that  they  can  possibly  have  with  surplus  is 
that,  if  unnecessarily  high,  they  will  be  sent  in  part  to  the 
credit  of  that  account,  in  order  to  remove  any  prejudice  that 
it  has  suffered  through  over-conservatism.  But,  until  they 
are  found  untrue  they  are  supposed  to  represent  true  cost, 
and  cannot  be  stated  otherwise  than  as  items  the  ultimate 
disposition  of  which  is  deferred. 

3.  Reserves  for  Surplus  Contingencies 

When  closing  the  books  for  the  purpose  of  ascertaining 
the  surplus  profits  of  a  period,  it  is  customary  to  take  as 
profits  the  net  fluctuations  of  assets,  representing  the  amount 


374    THE   THEORY   OF  THE   LIABILITY   ACCOUNTS 

by  which  incoming  values  have  exceeded  the  outgoing  values. 
Thus,  the  increase  of  incoming  claims  upon  customers,  over 
the  cost  of  outgoing  merchandise,  is  taken  as  the  gross 
profit.  But  it  may  happen  that  in  the  following  period,  ac- 
counts receivable  may  be  lost  through  the  failure,  the  lack 
of  good  faith,  or  the  financial  embarrassment  of  one  or  more 
customers.  The  account  being  lost,  it  remains  to  charge  it 
to  accumulated  profits,  under  the  form  of  surplus  adjust- 
ment, in  the  amount  of : 

a.  The  capital  lost 

b.  Profit  taken  as  such  during  the  prior  period,  and 

lost  during  the  present  one 

But,  since  losses  of  accounts  receivable  are  likely  to  be 
sustained,  it  is  advisable  at  the  end  of  any  given  period  to 
provide  for  them  by  appropriating  enough  of  the  very  profits 
which  the  account  brought  about;  which  reserve  must  con- 
tain not  only  its  quota  of  the  profits  which  may  be 
lost,  but,  as  well,  its  quota  of  the  capital  which  is  likely  to 
vanish. 

All  reserves  for  surplus  contingencies,  to  be  truly  re- 
serves, must  provide  either  for  possible  losses  of  capital,  or 
for  possible  losses  of  accumulated  surplus.  If  they  are  for 
contingencies  of  an  unknown  nature,  as,  for  instance,  a  sort 
of  insurance  against  problematic  financial  happenings,  they 
are  not  truly  reserves ;  they  are  surplus  temporarily  debarred 
from  dividend  distribution. 

4.  Reserves  for  Redemption  of  Debt 

It  is  a  well-established  principle  of  finance  that  debts  in- 
curred to  obtain  at  once  a  large  amount  of  capital  required 
for  improvements  or  additions  which  will  increase  earning 
power,  should  be  repaid  out  of  profits. 

If,  for  instance,  an  individual  borrows  $20,000  to  estab- 


RESERVES    AND    SURPLUS  37c 

lish  a  stage  line  between  two  towns,  it  must  be  that  he  has 
in  view : 

a.  To  obtain  the  necessary  equipment  out  of  money 

which  he  does  not  own,  and  which  represents  the 
wealth  of  somebody  else 

b.  To  obtain  out  of  that  equipment  an  income  which  his 

business  acumen  tells  him  will  be  large  enough  to : 
(i)   Meet   the   charges    for   interest   which   the 

lender  of  the  capital  will  make. 
(2)   Give  him,  the  borrower,  enough  of  a  re- 
mainder to : 

(a)  Live  from  the  fruit  of  his  industry 

(b)  Maintain  the  property  acquired  out  of 

the  money  borrowed 

(c)  Provide  for  the  natural  exhaustion  of 

the  property 

(d)  Repay  the  original  debt 

If  he  has,  perhaps,  been  able  to  persuade  the  lender  to 
accept  the  equipment  in  payment  of  the  debt  at  maturity,  he 
must  have  in  mind  to  set  aside  annually  out  of  his  income, 
enough  money  to  either  pay  the  loan  or  supply  him  with 
the  capital  necessary  to  acquire  new  equipment.  If  neither 
of  these  two  propositions  fits  in  with  his  purpose,  he  will, 
at  maturity  of  the  debt,  lose  both  the  equipment  and  the 
income. 

If  a  railroad  company  possessing  a  one-track  line,  and 
believing  that  a  two-track  line  will  double  its  income,  bor- 
rows enough  money  to  proceed  immediately  with  the  im- 
provement, instead  of  proceeding  gradually  by  reinvesting 
in  property  the  profits  obtained  from  the  original  investment, 
it  must  be  that  it  intends  to  repay  the  debt  out  of  profits.  If 
this  is  not  the  case,  how  will  the  debt  be  repaid  ?  Through 
the  sacrifice  of  the  assets  originally  obtained  out  of  contri- 
butions of  capital  ?    By  giving  back  that  part  of  the  capital 


376    THE  THEORY  OF  THE  LIABILITY   ACCOUNTS 

assets  obtained  out  of  the  debt  incurred?  If  the  former 
method  is  adopted,  what  sense  was  there  in  the  exchange? 
If  the  latter,  what  sense  was  there  in  borrowing?  The  bond- 
holders must  expect  their  bonds  to  be  paid  out  of  profits  and 
not  out  of  the  very  capital  which  their  money  has  pur- 
chased, since  that  capital  is  pledged  to  them  as  security; 
they  cannot  expect  to  be  paid  out  of  the  capital  acquired 
through  antecedent  liabilities  incurred,  since  that  capital  is 
pledged  to  others. 

Hence,  reserves  for  the  redemption  of  debts  must  be 
created  out  of  profits.  It  is  evident,  however,  that  if  suffi- 
cient profits  are  not  reserved  and  so  earmarked  that  it  will 
be  at  all  times  possible  to  identify  them,  their  purpose  may 
fail;  if  they  remain  in  the  free  surplus  they  may  be  dis- 
tributed as  dividends,  and  there  will  be  left  to  pay  the  debt 
nothing  but  the  pledge  more  or  less  depreciated,  the  sale  of 
which  will  deprive  the  borrower  of  the  very  asset  for  the 
acquisition  of  which  he  contracted  a  liability. 

Since  reserves  for  redemption  of  debts  must  be  created 
out  of  profits,  it  is  possible : 

a.  To  appropriate  surplus  earnings  as  measured  by  the 

Surplus  account,  or  by  the  periodical  profit  and 
loss.  This  appropriation  prevents  the  distribu- 
tion, under  the  form  of  dividends,  of  assets  repre- 
senting reinvested  profits. 

b.  To  set  aside  the  assets  themselves  by  taking  them 

out  of  the  general  fund  of  assets,  and  assigning 
them  to  a  sinking  or  redemption  fund. 

In  the  former  case  we  have  a  reserve  for  the  redemption 
of  a  debt ;  in  the  latter  case  we  have  a  sinking  or  a  redemp- 
tion fund.  Either  of  these  two  methods  is  adequate  of 
itself;  if  the  two  are  used  in  conjunction,  no  particular 
purpose  is  accomplished,  but  scrupulous  conservatism  is 
satisfied. 


RESERVES    AND    SURPLUS 


377 


5.  Secret  Reserves 

This  accounting  term  has  been  made  to  cover  a  multitude 
of  sins;  whenever  objection  is  taken  to  pessimistic  writing 
off  of  invested  values,  or  to  disproportionate  charges  for 
depreciation,  or  again  to  charges  to  operations  or  revenue, 
for  capital  expenditures  which  should  have  been  applied  to 
the  increase  of  assets,  the  answer  is,  "Secret  Reserves."  A 
manufacturer  of  prominence  in  the  City  of  New  York  once 
stated  to  the  writer,  in  a  tone  indicative  of  deep-rooted  pride, 
that  his  capital  assets  had  been  "bodily  knocked  down  into 
the  pit  of  secret  reserves,"  and  that  their  book  value,  as  it 
stood  at  the  time,  was  preposterous.  Since  the  said  manu- 
facturer was  the  president  of  a  corporation,  the  questions 
at  issue  were :  Did  he  want  to  deceive  the  stockholders,  the 
government,  the  public,  or  himself?  Did  he  wish  to  sub- 
mit to  the  directors,  the  stockholders,  the  banks,  and  the 
public,  financial  statements  with  a  mental  footnote  to  the 
effect  that  things  were  not  in  truth  what  they  showed  on 
their  face  ?  And  if  he  took  the  ground  that  it  is  well  to  hide 
your  wealth  from  some  people,  did  he  believe  that  anyone 
capable  of  reading  balance  sheets  is  not  in  a  position  to 
follow  accounting  facts  from  year  to  year,  and  to  point  out 
fluctuations  in  wealth  not  supported  by  the  statement  of  in- 
come submitted,  and  thus  unearth  secret  reserves  ? 

6.  Reserves  for  Exhaustion  of  Physical  Assets 

Certain  physical  assets  contribute  directly  to  the  produc- 
tion of  wealth,  and  others,  indirectly.  In  the  former  group 
we  find,  mines,  timber  lands,  etc.,  and  in  the  latter  group, 
plant,  machinery,  tools,  etc.  The  second  group  depreciates 
in  value  through  wear  and  tear;  while  the  first  becomes 
gradually  exhausted  as  it  yields  its  wealth. 

Since  it  is  undeniable  that  the  extraction  of  a  ton  of  ore 
has  exhausted  the  mine  in  the  amount  of  the  cost  of  that 
ton,  it  is  evident  that  the  investors  must  be  made  to  realize 


378    THE  THEORY  OF  THE  LIABILITY   ACCOUNTS 

that  all  returns  to  them  in  the  form  of  dividends  contain, 
besides  a  share  of  profits,  a  partial  repayment  of  capital; 
unless  there  has  been  appropriated  out  of  the  profits  realized 
on  the  sale  of  the  ore,  enough  to  provide  for  the  repayment 
of  the  capital  when  the  physical  assets  are  exhausted. 

The  foregoing  principles  apply  equally  as  well  to  the 
exhaustion  of  timber  lands  and  of  any  other  wealth-pro- 
ducing physical  asset  the  life  of  which  is  dependent  upon  its 
exploitation. 

Creation  of  Reserves 

As  suggested  in  the  foregoing,  reserves  taken  as  a  class 
of  items,  are  created  by  charges  to  cost  of  operations,  to  net 
profits  of  the  present  period,  or  to  accumulated  profits  of 
prior  periods,  and  by  corresponding  credits  to  individual  re- 
serve accounts,  or  to  classes  of  reserves;  but  the  provision 
which  they  attempt  to  make  for  losses  of  assets  is  just  as 
effectively  made  by  crediting  the  physical  assets,  whenever 
the  loss  is  so  positive  as  to  be  taken  as  cost  of  operations.  In 
such  cases,  if  a  reserve  is  set  up,  it  is  only  because  of  a  de- 
sire to  leave  the  original  cost  of  the  asset  undistributed  on 
one  side  of  the  scale,  and  to  place  on  the  other  side  a  counter- 
weight, establishing  the  difference  between  the  two. 

Provision  for  Depreciation 

To  provide  for  depreciation  of  physical  assets  so  that  they 
may  be  gradually  brought  down  to  zero,  or  to  their  residual 
value,  several  methods  are  available : 

I.  If  the  credit  is  to  be  given  to  the  asset: 

a.  Divide  the  amount  to  be  written  down  into  equal 
sums,  each  representing  the  loss  sustained  in  each 
successive  period  of  the  life  of  the  asset,  and  prc^- 
vide  for  each  such  sum  in  due  time. 


RESERVES    AND    SURPLUS  370 

b.  Write  oflf  periodically  a  sum  representing  a  fixed  per 

cent  of  the  residual  value  of  the  asset  at  the  be- 
ginning of  that  period. 

c.  Debit  the  asset  periodically    (and  credit  income) 

with  the  interest,  at  an  agreed  rate,  on  the  amount 
of  the  capital  invested  in  the  asset  at  the  begin- 
ning of  the  period,  and  write  ofif  periodically  the 
proper  instalment  of  an  annuity  so  calculated  as 
to  decrease  the  asset  to  zero,  or  to  its  residual 
value  at  the  end  of  its  effective  life. 

d.  Revalue  the  asset  at  the  end  of  each  period,  and  write 

off  the  periodic  decrease  in  value. 

2.  If  the  credit  is  to  be  given  to  a  reserve  account,  the 
methods  are  precisely  the  same  with  the  exception  that 
method  "b"  can  be  operated  only  by  obtaining  the  residual 
cost  by  means  of  periodically  comparing  the  amount  of  the 
reserve  with  the  original  cost  of  the  asset. 

The  comparative  value  of  the  above  methods  need  not  be 
discussed  at  length.  They  all  aim  at  the  equalization  of 
profits  by  making  each  successive  operating  period  bear  its 
share  of  the  loss  of  capital  assets.  It  must  be  stated,  how- 
ever, that  under  the  requirements  of  the  Interstate  Com- 
merce Commission  the  corporations  subject  to  its  accounting 
control  use  the  first,  that  is  to  say,  the  simplest,  method. 
Mr.  Hatfield*  states  that  the  second  method  "involves  a  com- 
plicated mathematical  calculation,  and  the  annual  rate  of  de- 
preciation gives  little  indication  to  the  ordinary  man  of  the 
period  required  to  write  off  the  asset.  Furthermore,  it  in- 
creases the  depreciation  charge  in  the  earlier  years,  and  in 
the  case  of  a  new  concern  this  may  be  distasteful  as  being 
an  additional  charge  against  profits  at  a  time  when  business 
has  not  come  into  full  swing,  and  profits  are  low." 

The  third  method  must  be  especially  distasteful  to  ac- 

*  "Modern  Accounting,"  page  ijo. 


38o 


THE   THEORY   OF  THE  LIABILITY    ACCOUNTS 


countants  who  do  not  believe  that  interest  on  invested  capital 
can  ever  be  a  charge  either  to  operations  or  to  assets,  or  a 
credit  to  income  or  profits. 

The  fourth  method  would  appear  to  offer  the  ideal  solu- 
tion of  a  difficult  problem  if  it  were  not  that  it  is  im- 
practicable so  far  as  the  average  enterprise  of  any  size  is 
concerned.  Also,  this  method  is  open  to  the  objection  that, 
while  an  appraisement  at  the  end  of,  say,  the  twentieth  year 
might  show  the  asset  to  have  a  relatively  large  salable  value, 
its  real  value  to  the  enterprise,  so  far  as  efficiency  is  con- 
cerned, might  be  insignificant. 

Provision  for  Exhaustion 

The  method  of  estimating  the  provision  to  be  made  for 
the  exhaustion  of  mines,  is  a  little  simpler  in  theory  than  the 
creation  of  reserves,  but  a  great  deal  more  complicated  in 
actual  practice. 

Theoretically,  it  is  plain  that,  while  the  lifting  to  the 
surface  of  a  ton  of  ore  has  exhausted  the  vein  to  the  benefit 
of  the  storeroom  or  the  ore  pile,  it  is  only  the  sale  of  that  ton 
which  depletes  the  wealth  of  the  mine.  Hence,  it  seems  that, 
if  provision  is  made  for  the  exhaustion  of  the  property,  it 
should  be  made  only  on  the  basis  of  the  tonnage  sold.  As  to 
the  amount  to  be  set  aside  out  of  the  profits  on  each  ton,  it 
should  be  such  as  to  amount  eventually,  together  with  the 
residual  value  of  such  other  assets  as  were  acquired  out  of 
capital  contributions,  to  the  amount  of  the  paid-up  capital. 

PROPRIETORSHIP   ACCOUNTS 
Positive  and  Negative  Components 

The  sum  of  the  assets,  less  the  sum  of  the  liabilities,  gives 
the  amount  of  the  proprietor's  equity  in  his  assets.  It  fol- 
lows that  every  account  which  appears  on  the  books  after  the 
closing  of  the  nominal  accounts  reflecting  the  causes  of  the 
fluctuation  of  values,  and  which  can  be  called  neither  an  asset 


PROPRIETORSHIP    ACCOUNTS 


381 


nor  a  liability,  must  be  either  a  positive  or  a  negative  com- 
ponent of  the  equity.  It  also  follows  that,  when  speaking  of 
the  proprietor's  equity  in  such  terms  as  "positive"  and  "neg- 
ative," we  must  apply  the  former  term  to  credit  components, 
and  the  latter  to  debit  components ;  whereas,  when  speaking 
of  assets  and  liabilities,  we  apply  the  term  "positive  values" 
to  debits,  and  the  term  "negative  values"  to  credits. 

The  components  of  the  equity  of  the  sole  proprietor  of  a 
business,  are: 

Negative  Positive 

Deferred  Debit  Items  Deferred  Credit  Items 

Drawing  Account  Undivided  Profits 

Capital  Account 

The  components  of  the  equity  of  the  copartners  are : 

Negative  Positive 

Deferred  Debit  Items  Deferred  Credit  Items 

Drawing  Account  (Debit       Drawing    Account    (Credit 
Balance)  Balance) 

Undivided  Profits 

Drawing  Accounts 

The  theory  of  the  drawing  account  of  the  sole  proprietor 
is  as  follows : 

It  must  contain,  on  the  credit  side,  the  profits  realized 
during  the  period,  and,  on  the  debit  side,  the  drawings  in 
anticipation  of  such  profits;  if  capital  is  withdrawn,  the 
amount  of  the  withdrawal  should  be  charged  to  the  capital 
account.  The  balance  of  the  drawing  account  should  repre- 
sent the  amount  by  which  the  profits  have  exceeded  the 
drawings  thereof,  or  the  amount  by  which  the  drawings 
have  exceeded  the  anticipated  profits ;  when  established,  the 
balance  should  be  closed  to  the  credit  or  to  the  debit  of  the 
proprietor's  capital  account. 


382     THE   THEORY    OF   THE   LIABIUTY    ACCOUNTS 

The  theory  of  the  drawing  account  of  copartners  is  as 
follows : 

Partners  may  draw,  according  to  their  articles  of  co- 
partnership : 

1.  In  anticipation  of  profits 

2.  For  bonuses,  salaries,  emoluments,  etc.,  accruing  to 

them  periodically 

3.  Capital 

Drawings  of  capital  should  be  charged  to  the  capital  ac- 
count; drawings  of  bonuses,  salaries,  and  so  forth,  should 
be  charged  to  special  credit  accounts  bearing  appropriate 
names  and  created  when  the  right  to  draw  has  matured. 
These  special  accounts,  when  created  or  increased  by  subse- 
quent credits,  constitute  liabilities  of  the  copartnership,  and 
should  not  be  credited  to  the  drawing  account,  which  is  to 
reflect  only  the  extent  of  the  drawings  in  anticipation  of 
profits.  The  drawing  account  proper  is  credited  with  the 
profits  when  ascertained,  and  debited  with  drawings  when 
made.  The  balance  of  the  account,  if  a  credit  balance, 
should,  according  to  the  spirit  of  the  articles  of  copartner- 
ship, be  sent  to  the  credit  of  the  capital  account,  or  to  a 
"Loan  Payable"  account ;  or  they  should  remain  in  the  draw- 
ing account  itself,  subject  to  the  pleasure  of  the  partner. 
These  credit  balances  are  not  to  be  treated  as  loans  to  the 
copartnership  unless  it  is  so  understood  among  the  partners. 

"Unapplied  profits"  are  nothing  more  than  the  balance  of 
the  profit  and  loss,  the  ultimate  disposition  of  which  is  un- 
certain. It  may  be  withdrawn  by  the  proprietor  or  he  may 
reinvest  it.  In  the  latter  case  it  will,  in  due  course,  be  sent 
to  his  capital  account. 

"Undivided  profits"  when  found  in  the  accounts  of  co- 
partners, indicate  that  while  the  profits  are  to  be  ascertained 
monthly,  quarterly,  or  semiannually,  they  are  to  be  divided 
among  the  partners  at  certain  stated  periods  only. 


PROPRIETORSHIP    ACCOUNTS 


383 


The  capital  account,  when  analyzed,  must  g^ve  the  fol- 
lowing components : 


Negative 

1.  Original  Liabilities 

2.  Net  periodical  excess  of 

decreases  of  assets,  plus 
increases  of  liabilities 
over  increases  of  assets, 
plus  decreases  of  lia- 
bilities, after  addition 
thereto  of  drawings  of 
anticipated  profits 


Positive 

1.  Original  Assets 

2.  Net  periodical  excess  of 

increases  of  assets,  plus 
decreases  of  liabilities 
over  decreases  of  as- 
sets, plus  increases  of 
liabilities,  after  deduc- 
tion of  drawings  of  an- 
ticipated profits  in  an 
amount  smaller  than 
the  profits 


Part  V — Financial  Statements 


CHAPTER  XXXIII 

FINANCIAL  STATEMENTS   BASED   ON   SINGLE 

ENTRY 

The  Statement  of  Assets  and  Liabilities 

The  theory  and  the  mechanism  of  this  statement  have 
been  treated  in  detail  in  the  discussion  of  single  entry.* 
No  further  comments  are  at  present  necessary,  except  to 
point  out  that  the  statement  has  a  twofold  purpose,  in  that 
it  attempts  to  show  the  financial  status  by  means  of  inven- 
tories, and  to  marshal  fluctuations  of  invested  values  in  order 
that  their  meaning  may  be  clearly  expressed  by  the  state- 
ment of  resources  and  of  their  application. 

The  Statement  of  Resources  and  of  Their  Application 

This  statement  is  based  not  only  upon  accounting  prin- 
ciples but,  as  well,  upon  a  principle  of  economics.  For  every- 
thing which  one  receives,  one  has  to  give  up  something 
already  in  possession,  either  in  the  line  of  wealth  or  in  the 
line  of  credit.  If  this  is  not  the  case,  the  recipient  must 
have  been  the  beneficiary  of  a  gift,  a  legacy,  a  bequest,  or  a 
devise. 

Recognizing  this  principle,  and  applying  it  to  the  busi- 
ness concern,  the  statement  of  resources  claims  that  re- 
sources include,  assets  once  held  but  now  consumed;  credit 

•  See  Chapter  V. 


STATEMENTS    BASED    ON    SINGLE    ENTRY 


385 


once  enjoyed  but  now  partially  exhausted  through  usage; 
and  increases  of  wealth  reinvested. 

If  an  individual  has  $100  in  the  bank,  he  has  an  asset; 
if  he  draws  $25  for  a  suit  of  clothes,  he  turns  part  of  his 
asset  into  a  resource  which  he  applies  to  the  acquisition  of  an 
asset  of  a  different  nature.  If,  instead  of  consuming  his 
asset,  he  acquires  the  suit  of  clothes  upon  a  promise  to  pay 
in  the  future,  he  has  turned  his  credit  into  a  resource  which 
he  has  applied  to  the  acquisition  of  an  asset  which  he  did  not 
possess  at  the  beginning  of  the  period ;  but  he  has  partially 
consumed  his  credit,  and  to  reestabHsh  it,  he  will  have  to 
consume  his  asset  "cash." 

If  a  business  concern  has  obtained,  at  the  end  of  a  period : 

1.  New  assets  that  it  did  not  have  at  the  beginning 

2.  Increases  of  assets  held  at  the  beginning 

3.  Decreases   of  liabilities   liening  the  assets   at  the 

beginning 

it  must  have  consumed : 

1.  Certain  assets  held  at  the  beginning 

2.  A  certain  amount  of  its  credit 

And  if  the  aggregate  of  the  things  obtained  has  been  greater 
than  the  aggregate  of  the  consumption  of  assets  and  credit 
owned  and  enjoyed  at  the  beginning  of  the  period,  there 
must  have  been  received  during  the  period,  profits  which 
have  also  been  applied  to  the  acquisition  of  wealth. 

To  illustrate  the  foregoing,  there  will  be  demonstrated 
one  of  the  practical  problems  of  the  New  York  C.  P.  A 
examination  of  January,  1912. 

Problem 

The  following  is  a  comparative  balance  sheet  at  Decem- 
ber 31,  19 10,  and  at  December  31,  191 1,  presented  to  the 
directors  of  the  Western  Company  at  their  meeting  of  Jan- 
uary 5,  1912: 


^85  FINANCIAL    STATEMENTS 

Assets 

12/31/1910  12/31/1911 

Land $20,000  $25,000* 

Buildings 45,ooo  45,ooo 

Machinery  and  Tools 86,000  b9,ooo     - 

Horse,  Wagon,  and  Harness 10,500  10,500 

Patents 6,000  6,000 

Good- Will 25,000  25,000 

Cash 28,300  10,300 

Accounts  Receivable 29,600  25,550 

Investments — Bonds   15.000 

Inventory  of  Goods  in  Process 10,800  14,690 

Inventory  of  Materials  and  Supplies 6,750  10,300 

Agency    Investment 3.680 

$267,950  $281,020 

Liabilities 

12/31/1910  12/31/1911 

Bond  and  Mortgage  Payable,  1915 $20,000 

Notes  Payable $35,ooo  2,000 

Accounts  Payable 16,400  I9.350 

Reserves  for  Depreciation 2,500  6,750 

Discount  on  Bonds 1,000 

Capital  Stock : 

Preferred 150,000  150,000 

Common  50,000  50,000 

Surplus   14,050  31,920 


$267,950        $281,020 


*  Increase  due  to  appraisal  based  on  rise  in  values  of  factory  sites  in  the  immediate 
vicinity. 

Together  with  the  above  balance  sheet,  there  was  sub- 
mitted to  the  board  of  directors  a  statement  of  income  and 
profit  and  loss  showing  the  profits  of  the  year  191 1  to  have 
been  $22,120.  The  directors  state  to  the  auditor  that,  in 
view  of  the  decrease  of  cash  and  of  the  increase  of  capital 
liabilities,  they  are  unable  to  ascertain  what  has  become  of 
the  increased  profits  of  the  year.    The  auditor  prepares  and 


STATEMENTS    BASED    ON     SINGLE    ENTRY 


387 


submits  to  the  directors,  before  the  meeting  is  adjourned,  an 
account  properly  named,  which  is  so  arranged  as  to  show 
clearly  how  the  Western  Company  has  applied  such  re- 
sources of  the  year  191  o  as  have  been  lost  in  191 1,  and  the 
resources  and  profits  of  the  year  191 1. 

Prepare  the  account  rendered  by  the  auditor. 

Solution 

It  is  presumed  that,  for  the  enlightenment  of  the  direc- 
tors, the  comparative  balance  sheet  submitted  to  them  ex- 
hibited the  increases  and  decreases  of  the  present  period  over 
the  last  period.  At  all  events,  they  must  be  obtained  before 
the  statement  of  resources  can  be  established.  This  done,  the 
factors  which  have  contributed  to  the  increase  of  wealth 
(i.e.,  increases  of  assets  and  decreases  of  liabilities)  and  the 
factors  which  have  contributed  to  the  decrease  of  wealth 
(i.e.,  decreases  of  assets  and  increases  of  liabilities)  are  op- 
posed as  shown  on  page  388. 

It  will  be  noted  that  the  $15,000  increase  of  assets  rep- 
resented by  the  account  "Investments  in  Bonds,"  has  only 
consumed  $14,000  of  other  assets,  since  it  has  been  acquired 
at  a  discount  of  $1,000,  and  that  only  the  actual  cost  can  be 
employed  to  represent  an  asset  consumed  to  acquire  another ; 
that  the  profits  reinvested  are  not  the  amount  shown  by  the 
statement  of  income,  but  are  only  part  of  the  total  profits 
which  were  actually  received;  in  other  words,  since  only 
$21,050  of  the  assets  of  the  prior  period  and  $22,950  of 
credit  of  the  prior  period  have  been  consumed  to  acquire 
$28,120  of  new  assets  and  to  rehabilitate  the  concern's 
credit  in  the  amount  of  $33,000,  the  excess  of  applications 
over  the  consumption  of  resources  must  have  been  produced 
by  such  profits  as  were  actually  received  in  cash. 

If  the  consumption  of  resources  represented  by  decreases 
of  assets  and  increases  of  liabilities  is  greater  than  the  ap- 


388 


FINANCIAL    STATEMENTS 


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STATEMENTS    BASED    ON    SINGLE    ENTRY 


389 


plication,   the   statement   will   end   on   the   credit   side   as 
follows : 

"To  pay  for  the  cost  of  conducting  the  business,  over 
and  above  the  return  thereof  in  the  line  of  profits,"  or  some 
such  appropriate  explanation. 

Proof  of  Ledger  Assets 

The  Insurance  Department  of  the  State  of  New  York  re- 
quires insurance  companies  to  submit  a  statement  calling 
for: 


1.  Amount  of  ledger  assets  at  beginning  of 

the  year $. 

2.  Income  of  the  year 


Total $. 

3.  Disbursements  of  the  year 


Balance — representing  assets  at  the  end 
of  the  year $ . 


Recognizing  the  principles  of  accounting  supporting  the 
insurance  statement,  the  New  York  Board  of  C.  P.  A.  Ex- 
aminers applied  these  same  principles  to  a  mercantile  busi- 
ness, and  built  up  an  examination  problem  in  June,  1912, 
which  was  severely  criticized  by  accountants  who  claimed 
that  it  was  impossible  to  start  with  the  amount  of  assets 
at  the  beginning  of  the  period,  add  the  income,  deduct  cash 
disbursements,  and  arrive  at  the  assets  at  the  end. 

The  criticism  is  based  on  sandy  foundations.  In  account- 
ing parlance,  the  word  "disbursements"  applies  to  cash,  only 
if  it  is  qualified  as  "cash  disbursements."  Speaking  from 
the  broad  point  of  view  of  principles  of  accounting,  an  asset 
consumed  is  an  asset  disbursed,  while  cash  disbursed  to 
acquire  another  asset  is  not  a  disbursement  of  an  asset,  but 


200  FINANCIAL    STATEMENTS 

merely  reflects  an  exchange.  To  illustrate  the  foregoing, 
there  is  submitted  a  problem  which  is  modeled  upon  the  lines 
of  the  New  York  C.  P.  A.  problem  referred  to ;  it  appears  to 
have,  over  its  predecessor,  the  advantage  of  presenting  the 
problematic  requirements  in  a  more  lucid  manner. 

Problem 

The  ledger  of  the  Secaucus  Supply  Company  shows  at 
January  i,  19 14: 

Debits : 

Land  and  Buildings,  $30,500;  Delivery  Equipment, 
$5,000;  Investment  Bonds,  $9,500;  Inventory  Mer- 
chandise, $12,000;  Stable  Supplies,  $150;  Cash, 
$16,500;  Accounts  Receivable,  $14,800. 

Credits : 

Accounts  Payable,  $9,000;  Surplus,  $17,450;  Mortgage 
Payable,  $12,000;  Capital  Stock,  $50,000. 

The  books  show  at  June  30,  1914 : 

Cash  Book: 

Capital  Stock,  $5,000;  Customers,  $35,000;  Interest 
on  Investments,  $400;  Interest  on  Bank  Balances, 
$80;  Mortgage  Payable  reduced,  $3,500;  Creditors, 
$20,000;  Delivery  Equipment,  $300;  Freight,  $425; 
Stable  Supplies,  $200;  Salaries  of  Salesmen,  $1,500; 
Advertising,  $50;  Administrative  Expense,  $6,500; 
Interest  on  Mortgage,  $150. 

Profit  and  Loss  Account : 

Debits : 

Purchases,  $20,000;  Freight  outward  and  inward, 
$425 ;  Stable  Supplies,  $235 ;  Salaries  of  Sales- 
men, $1,575;  Advertising,  $50;  Administrative 
Expense,  $6,500;  Interest  on  Mortgage,  $210. 


STATEMENTS    BASED    ON    SINGLE    ENTRY        391 

Credits : 

Interest  on  Investments,  $490 ;  Interest  on  Bank  Bal- 
ance, $80;  Sales,  $38,500;  Increase  of  Merchan- 
dise Inventory,  $500. 

Required : 

1.  A  statement  which  will  give  full  expression  to  the 

following  formula: 

"Initial  Assets"  plus  "Income  of  the  Period"  less 

"Disbursements  of  the  Period"  equal  "Assets 

at  the  Close  of  the  Period." 

2.  The  balance  sheet  of  the  company  at  June  30,  1914, 

supporting  the  total  of  the  assets  shown  by  state- 
ment I. 

Note:   The  accounting  period  extends  from  January  i, 
1914,  to  June3o,  1914. 

In  connection  with  the  solution  of  this  problem — which 
appears  on  the  pages  immediately  following — it  is  pointed 
out: 

1.  That  the  sale  of  the  capital  stock  in  the  amount  of 

$5,000  has  increased  the  asset  "cash,"  not  through 
the  channel  of  income,  but  through  the  incurrence 
of  a  liability  to  stockholders. 

2.  That  adding  the  amount  received  from  capital  con- 

tributions to  the  original  assets,  we  obtain  the 
total  amount  of  assets  with  which  the  concern 
started,  and  the  addition  thereto  through  sources 
not  directly  connected  with  income. 

3.  That  if  we  add  to  this  total  of  assets,  all  the  income 

of  the  period,  whether  received  or  accrued,  we 
have  taken  cognizance  of  all  the  positive  fluctua- 
tions of  the  assets,  and  that  the  result  of  the  addi- 


392 


FINANCIAL    STATEMENTS 


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^g^  FINANCIAL    STATEMENTS 

tion  would  be  the  amount  of  the  concern's  asset"? 
if  it  had  cost  nothing  to  obtain  the  income. 
4.  That  the  cost  of  obtaining  income  can  only  be  that 
which  has  consumed  assets,  and  must  exclude  that 
which  has  brought  about  the  recording  of  an  ac- 
crued liability. 
To  make  this  still  clearer : 
Stable  supplies  show  at  the  beginning  of  the 

period  a  value  of $150.00 

During  the  period  there  have  been  purchased 

for  cash 200.00 

Total $350.00 

There  has  been  charged  to  profit  and  loss,  as 

expended 235.00 

Leaving  a  remainder  of $1 15.00 

Hence,  the  disbursement  of  the  asset  has  been  not  $200 
disbursed  in  cash,  but  that  amount  plus  $35  of  the 
original  asset  held  at  the  beginning  of  the  period,  and 
now  consumed. 

An  essential  principle  to  be  borne  in  mind  when  pre- 
paring this  statement,  is  that  all  the  accruals  of  income 
credits  must  be  considered,  since  they  affect  the  assets; 
whereas  all  the  accruals  of  income  debits  must  be  ignored, 
since  they  only  affect  liabilities.  Consider,  for  instance,  the 
salaries  of  the  salesmen:  $1,500  was  paid  in  cash,  while 
$1,575  w^s  charged  to  profit  and  loss;  the  only  part  of 
the  expense  which  affected  assets  is  the  part  paid  in  cash ; 
hence,  it  is  the  only  one  of  which  the  statement  takes 
cognizance. 

The  first  and  second  statements  discussed  above  are  said 
to  be  based  on  single  entry,  because  they  can  be  established 
from  books  kept  in  accordance  with  the  principles  of  that 
method  of  bookkeeping  which  recognizes  only  inventories 


STATEMENTS    BASED    ON    SINGLE    ENTRY 


395 


of  assets  and  liabilities  revealing  increases  and  decreases, 
without  regard  to  the  causes  which  brought  about  the  fluctu- 
ations. As  to  the  third,  it  is  based  on  the  same  principles, 
since  it  considers  only  increases  and  decreases  of  assets  with- 
out regard  to  the  nature  of  the  bookkeeping  entries  which 
gave  expression  to  their  counterpart. 


CHAPTER   XXXIV 

TRIAL  BALANCE— WORKING  BALANCE  SHEET 

Trial  Balance 

The  trial  balance  is  not  a  financial  statement;  it  is 
merely  a  list  of  the  balances  of  the  accounts  remaining-  open 
on  a  double-entry  ledger  at  sundry  times,  i.e. : 

1.  After  the  posting  of  the  transactions  of  the  month, 

as  reflected  by  the  books  of  original  entry. 

2.  After  the  posting  of  the  accruals  and  of  the  in- 

ventories, and  the  possible  adjustment  of  accounts, 
due  to  a  desire  for  more  accurate  or  more  exten- 
sive distribution. 

3.  After  the  posting  of  the  closing  entries  which  estab- 

lish the  profit  and  loss  account  and  either  leave  it 
as  it  then  stands,  until  the  directors  have  passed 
upon  its  disposition,  or  send  it  to  the  credit  of  the 
accounts  entitled  thereto. 

The  trial  balance,  in  fact,  is  nothing  more  than  a  surface 
indication  that  the  books  are  in  balance,  and  that  the  trans- 
actions have  been  accurately  recorded. 

Classified  Trial  Balance,  or  Working  Balance  Sheet 

Here  again  we  have  a  statement  which  cannot  be  called 
financial;  it  leads  to  the  establishment  of  the  balance  sheet 
and  of  the  statement  of  income  and  profit  and  loss  by  means 
of  the  following  process : 

I.  It  classifies  the  trial  balance  so  as  to  gather,  either 
on  separate  sheets,  or  on  the  opposite  sides  of  a  sheet  divided 

396 


TRIAL   BALANCE— WORKING   BALANCE   SHEET 


397 


in  the  middle,  real  accounts,  accounts  partially  real  and 
partially  nominal,  and  nominal  accounts  having  a  debit 
balance;  liabilities,  surplus,  components,  free  or  appro- 
priated, and  nominal  accounts  having  a  debit  balance. 

2.  It  provides  for  journal  adjustments,  debits,  and 
credits,  necessary  to  apply  inventories  or  to  redistribute 
certain  items. 

3.  It  classifies  the  resulting  figures  as  between : 

a.  Income  debits  and  assets 

b.  Income  credits  and  liabilities 

In  fact,  it  aims  at  the  presentation  of  a  picture  of  a  gen- 
eral ledger  subdivided  into  the  assets  and  liabilities  section, 
and  the  income  section.  When  completed,  its  accuracy  is 
determined  by : 

1.  Adding  together  the  trial  balance  debits  and  the 

debit  journal  adjustments,  and  deducting  from  the 
total  thus  obtained  the  credit  journal  adjustments, 
and  comparing  the  remainder  with  the  total  of  the 
assets  and  of  the  income  debits. 

2.  Adding  together  the  trial  balance  credits  and  the 

credit  journal  adjustments,  and  deducting  from 
the  total  thus  obtained  the  debit  journal  adjust- 
ments, and  comparing  the  remainder  with  the 
total  of  the  liabilities  and  of  the  income  credits. 

The  working  balance  sheet  as  described  is  frequently 
used  by  accountants  who,  having  to  establish  financial  state- 
ments within  a  stated  period,  find  the  general  ledger  in- 
complete, improperly  kept,  or  grossly  inaccurate.  They  take 
as  a  starting  point  a  trial  balance  the  exactness  of  which  has 
been  established,  gather  the  facts  of  the  subsequent  period 
from  the  books  of  original  entry,  journalize  the  results, 
and  post  them  on  the  working  sheet,  which  is  thus  raised  to 
the  dignity  of  a  ledger. 


398 


FINANCIAL    STATEMENTS 


The  handling  of  the  working  balance  sheet  is  at  no  time 
difficult;  however,  it  cannot  be  used  successfully  by  anyone 
not  thoroughly  familiar  with  the  mechanism  of  ledger  ac- 
counts. To  illustrate  this  point,  let  us  attempt  to  use  the 
sheet  described  in  the  foregoing,  for  the  solution  of  a  New 
York  C.  P.  A.  examination  problem. 

Problem 
(New  York  C.  P.  A.  Examination,  June  30,  19 12)* 

The  following  balances  are  taken  from  the  books  of  the 
Roberts  Manufacturing  Co.  of  New  York  City,  on  the  31st 
of  December,  19 10: 

Inventory  of  Finished  Goods  (Jan.  i ) $3,684.57 

Inventory  of  Raw  Materials  (Jan.  i) 11,392.70 

Purchases  of  Raw  Materials 62,519.85 

Sales 217,387.42 

Wages   109,317.88 

Rent   19,500.00 

Discounts  Received  on  Purchases 375-6o 

Discounts  Allowed  on  Sales 186.36 

Power,  Light,  and  Heat 8,710.64 

Light  and  Heat  for  Office 168.00 

Repairs  1,090.00 

Packing   2,017.00 

Factory  Expense 3.270.00 

General    Expense 5,230.00 

Factory  Insurance 1,050.00 

General  Insurance 750.00 

Machinery  and  Plant 12,350.00 

Tools    2,600.00 

Commissions    7,642.00 

Office    Salaries 9,700.00 

Salesmen's  Salaries 8,930.00 

Interest  on  Loans 440.00 

Loans  Payable 22^000.00 

Discount  Lost 120.00 

Notes  Receivable 130,000.00 

Notes  Receivable,  Discounted 8,000.00 

Notes   Payable 19,500.00 


*  Certain  of  the  requirements  of  this  problem  have  been  omitted,  as  having  no 
connection  with  the  purpose  of  the  illustration. 


TRIAL   BALANCE— WORKING   BALANCE   SHEET    399 

Accounts  Receivable 101,026.00 

Accounts    Payable 30,020.00 

Office  Furniture 1,100.00 

Furniture  and  Fixtures I,95aoo 

Cash  on  Hand 1,825.00 

Cash  in  Banks 26,467.00 

Returned  Sales 276.00 

Capital  Stock : 200,000.00 

Reserve  for  Depreciation 3,236.98 

Reserve  for  Bad  Debts 5,727.00 

Freight  and  Cartage  Inward 727.00 

Stable    Expenses 2,750.00 

Horses,  Wagons  and  Harness 8,500.00 

Postage  and  Expressage 1,250.00 

Superintendence 3,500.00 

Taxes 250.00 

Good- Will  10,000.00 

Stationery  and  Printing 1,080.00 

Advertising    8,630.00 

Surplus    (1909) 63,753.00 

1.  Prepare  from  the  above  a  trial  balance  arranged  in 
systematic  order,  so  as  to  facilitate  the  preparation  of  finan- 
cial or  business  statements. 

2.  Draft  journal  entries  for  closing  the  books. 

The  following  items  are  to  be  taken  into  consideration : 

Inventories : 

Raw  Materials $16,250.00 

Finished  Goods 9,386.00 

Tools    2,000.00 

Office  Furniture 1,000.00 

Furniture  and  Fixtures 1,500.00 

Stationery  and  Printing 300.00 

Allow  for  depreciations:  on  machinery,  5%;  on  horses, 
wagons  and  harness,  10%. 

Reserve  for  bad  debts,  3%  on  accounts  receivable  only. 

The  item  for  rent,  $19,500,  is  to  be  apportioned  as  fol- 
lows: S3%  fo^*  factory,  22%  for  salesrooms,  and  25%  for 
office. 

The  item  of  superintendence,  $3,500,  is  to  be  divided, 
ys  to  factory  and  ^  to  general  expense. 


40O  FINANCIAL    STATEMENTS 

Solution 
« 

The  arrangement  of  the  trial  balance  need  not,  in  this 
instance,  be  particularly  respectful  of  the  different  theories 
which  dictate  the  position  to  be  occupied  in  the  statement  of 
income  by  the  sundry  elements  of  income,  profits,  expenses, 
and  losses.  These  theories  will  be  fully  explained  later. 
Let  it  be  sufficient,  at  this  point,  to  be  orderly  and  logical. 
The  purpose  of  the  working  sheet  will  stand  out  clearly  at 
all  events. 

Having  classified  the  trial  balance,  the  first  care  should 
be  to  journalize  the  adjustments  to  be  made,  and  to  post  the 
journal  entries  in  the  working  papers,  precisely  as  we  would 
in  the  ledger. 

Journal  Entries 

Inventory  Raw  Materials — New  Account $16,250.00 

Inventory  Finished  Goods      "  "  9,386.00 

Tools  "  "  2,000.00 

Office  Furniture  "  "  1,000.00 

Furniture  and  Fixtures  "  "  1,500.00 

Stationery  and  Printing  "  "  300.00 

To  Inventory  Raw  Materials — Old  Account  $16,250.00 

"  Inventory  Finished  Goods      "  "  9,386.00 

"  Tools  "  "  2,000.00 

"  Office  Furniture  "  "  1,000.00 

"  Furniture  and  Fixtures  "  "  1,500.00 

"  Stationery  and  Printing  "         "  300.00 

To  apply  closing  inventories. 

Provision    for    Depreciation    of    Machinery    and 

Plant,  5% 617.50 

Provision   for  Depreciation   of   Delivery   Equip- 
ment, 10% 850.00 

To  Reserve  for  Depreciation 1,467.50 

To  provide  for  depreciation  of  physical  assets. 

Reserve  for  Bad  Debts 2,696.22 

To  Surplus 2,696.22 

To  reduce  reserve  to  3%  of  balance  of  asset 
account,  i.e.,  $ioi,026.oa 


TRIAL   BALANCE— WORKING   BALANCE   SHEET 


401 


Factory  Rent  53% 10,335.00 

Rent  of  Salesroom  22% 4,290.00 

Rent   of   Office  25% 4,875.00 

100% 
To   Rent 

To  distribute. 

Superintendence — Factory    3/5 3,100.00 

Office  Salaries  2/S 1,400.00 

5/5 
To   Superintendence 

To  distribute. 

Tools    Consumed 600.00 

Furniture  and  Fixtures  Written  Off 450.00 

Office  Furniture  Written  Off 100.00 

To  Tools  , 

"  Furniture  and  Fixtures 

"  Office   Furniture 

To  apply  loss  due  to  reappraisal  of  above 
properties. 

Stationery  and  Printing  Consumed 780.00 

To  Stationery  and  Printing 

To  take  out  of  asset  account  the  part  of  it 
which  is  nominal. 

Inventory  of  Raw  Materials 4,857.30 

To  Profit  and  Loss 

For  increase  of  inventory.  This  will  act  in  the 
Profit  and  Loss  account  as  a  reduction  of 
the  cost  of  goods  purchased,  and  determine 
the  cost  of  goods  manufactured. 

Inventory  of  Finished  Goods — Old  Account 5,701.43 

To  Profit  and  Loss 

For  increase  of  inventory.  This  will  act  in  the 
Profit  and  Loss  account  as  a  reduction  of 
the  cost  of  goods  manufactured,  and  deter- 
mine the  cost  of  goods  sold. 


19,500.00 


3,500.00 


600.00 
450.00 
100.00 


780.00 


4,857.30 


5,70143 


The  adjusting  entries  having  been  made,  the  closing 
entries  would  consist  in  gathering  all  items  constituting 
classes  of  economic  facts,  and  closing  them  by  classes  in  the 
Profit  and  Loss  account,  in  order  to  make  the  latter  repro- 
duce accurately  the  skeleton  of  the  statement  of  income  and 


402 


FINANCIAL    STATEMENTS 


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TRIAL   BALANCE— WORKING   BALANCE   SHEET    405 

profit  and  loss;  these  entries  will  be  omitted  here  as  im- 
material so  far  as  the  illustration  of  the  working  sheet  is 
concerned. 

The  picture  presented  by  the  foregoing  working  balance 
sheet  is  an  exact  reproduction,  just  before  closing,  of  a 
highly  analytical  and  well-planned  ledger.  Sometimes  the 
accountant  carries  his  preliminary  work  still  further,  and 
distributes  the  income  debits  and  credits  as  follows : 

1.  Distribution  of  Income  Debits 

a.  Cost  of  Goods 

(i)  Labor 

(2)  Material 

(3)  Overhead 

b.  Shipping  Expense 

c.  Selling  Expense 

d.  Administrative  Expense 

e.  Deductions  from  Income 

f.  Profit  and  Loss  Debits 

g.  Surplus  Adjustment 

h.  Deductions  from  Income  from  Sales 

2.  Distribution  of  Income  Credits 

a.  Income  from  Sales 

b.  Additions  to  Income 

c  Profit  and  Loss  Credits 
<L  Surplus  Adjustment 


CHAPTER    XXXV 

THE    BALANCE    SHEET 

Arrangement  as  to  Assets  and  Liabilities 

The  balance  sheet  exhibits  the  balances  of  the  real  ac- 
counts open  on  the  books  after  the  closing-  of  the  nominal 
accounts.  Whether  these  balances  shall  be  presented  in  ac- 
count form,  i.e.,  assets  on  one  side  and  liabilities  on  the 
other  side  of  a  sheet  divided  in  the  middle,  or  in  statement 
form,  i.e.,  assets  following  liabilities,  or  vice  versa,  is  imma- 
terial to  accounting. 

Whether  the  assets  are  shown  on  the  credit  side  or  on 
the  debit  side,  depends  upon  the  point  of  view.  If  we  con- 
sider the  balance  sheet  as  a  classified  statement  of  financial 
facts  contained  in  the  general  ledger,  we  shall  naturally 
present  the  facts  as  they  stand  on  the  ledger,  that  is  to  say, 
debits  on  the  left  and  credits  on  the  right  if  the  account  form 
is  adopted,  or  assets  first  and  liabilities  second  if  the  state- 
ment form  is  adopted. 

It  has  been  said  by  English  accountants  that  the  balance 
sheet  is  an  account  rendered  by  the  business  to  the  proprietor. 
If  we  accept  this  view,  we  must  credit  the  proprietor  with  his 
assets  and  debit  him  with  his  liabilities.  If,  on  the  other 
hand,  we  take  the  balance  sheet  to  be  purely  and  simply  a 
concrete  presentation  of  financial  facts,  we  must  understand 
the  business  venture  to  say : 

1.  I  have 

2.  I  owe 

406 


THE    BALANCE    SHEET  ^O/ 

Arrangement  as  to  Order  of  Items 

The  desire  of  accountants  to  make  the  balance  sheet 
valuable  as  a  logical  presentation  of  facts,  has  led  them  to 
build  it  up  on  lines  which  are  as  varied  as  the  range  of  their 
minds.     Some  practitioners  oppose : 

1.  Capital  assets  and  working  and  trading  assets  to 

capital  liabilities 

2.  Current  assets  to  current  liabilities 

3.  Deferred  debit  items  to  deferred  credit  items 

Group  I  represents  the  actual  investment  of  capital  con- 
tributed or  borrowed,  in  fixed  assets  and  in  assets  remaining 
unconsumed  in  pursuance  of  the  purpose  of  the  business. 

Group  2  represents  the  excess  of  liquid  assets  over 
the  amount  of  short-term  debts,  or  vice  versa. 

Group  3  represents  positive  and  negative  elements  the 
application  of  which  to  income  is  postponed  until  a  subse- 
quent period. 

The  result  represents  the  equity  in  undivided  profits  re- 
invested, and  either  appropriated  for  reserves,  or  free  for 
distribution ;  and,  by  adding  to  this  the  capital  account  of  the 
private  trader,  or  the  capital  stock  of  the  corporation,  the 
true  equity  of  the  interested  parties  is  found.  This  is  illus- 
trated by  the  balance  sheet  which  follows : 

General  Balance  Sheet  of  the  X.  Y.  Z.  Company 
AT  December  31,  19 13 

Assets 

Capital  Assets: 

Land $5,ooo.oo 

Building    10,000.00 

Machinery  and  Tools 11,300.00 

Transportation  Equipment 2,5oaoo    $28,800.00 


4o8  FINANCIAL    STATEMENTS 

General  Balance  Sheet — Continued 

Working  and  Trading  Assets: 

Inventory  of  Merchandise $16,950.00 

Stable  Supplies 330.00 

Stationery  and  Printing 140.00      17,420.00 

Current  Assets: 

Cash $7,830.00 

Notes  Receivable 4,000.00 

Accounts  Receivable 10,385.00      22,215.00 

Deferred  Debit  Items: 

.  Rent — unexpired  portion $60.00 

Insurance — unexpired  portion 80.00  140.00 

Total $68,575.00 


Liabilities 
Capital  Liabilities: 

Capital  Stock $40,000.00 

Mortgage   Payable 5,800.00    $45,800.00 

Current  Liabilities: 
Accounts   Payable 12,350.00 

Surplus: 

Free  $8,42500 

Appropriated : 

Reserve  for  Depreciation 1,000.00 

Reserve  for  Bad  Debts 1,000.00      10,425.00 

Total $68,575.00 


Equity  of  stockholders : 

Assets $68,575.00 

Liabilities  exclusive  of  capital  stock 18,150.00 

Excess  of  assets  over  liabilities  to  outsiders , $50,425.00 


THE    BALANCE    SHEET  409 

Equity  rq)resented  by : 

Capital  stock $40,000.00 

Surplus : 

Free $8,425.00 

Appropriated   2,000.00      10425.00 

$50,425.00 


Variations  in  Arrangement  of  Balance  Sheet 

Other  accountants  prefer  to  exhibit  first  of  all  the  liquid 
assets  opposed  to  liquid  liabilities.  They  claim  that  nothing 
matters  more  to  the  reader  of  the  statement  than  the  ex- 
tent of  the  free  capital  available  for  current  needs.  Still 
others  like  to  show  : 

1.  All  the  assets,  without  particular  regard  to  their 

classification 

2.  All  the  liabilities  to  outsiders 

3.  The  extent  of  the  proprietorship  represented  by : 

a.  Capital  investments  as  shown  by  capital  ac- 

counts or  capital  stock 

b.  Surplus 

c.  Reserves 

d.  Deferred  credit  items 

Lastly,  some  will  show  all  reserves  as  deductions  from 
the  assets  for  which  they  provide,  while  others  will  show 
them  either  as  liabilities  or  as  proprietorship. 

It  is  certain  that  in  the  expression  of  the  facts,  the  in- 
dividual accountant  is  guided  either  by  his  purpose  or  by  the 
extent  of  his  conception  of  the  science  of  accounting.  To 
criticize  is  often  tantamount  to  a  lack  of  appreciation  of  the 
guiding  purpose,  or  to  lack  of  charity  for  the  supposed  short- 
comings of  men  whom  we  measure  according  to  our  own 
exalted  standards.     It  remains  true,  however,  that  the  bal- 


4IO  FINANCIAL    STATEMENTS 

ance  sheet  of  going  concerns  is  built  up  around  principles 
of  economics,  of  finance,  and  of  business  common  sense. 

The  unsophisticated  student  of  accounting  can  readily 
be  made  to  understand  that  a  balance  sheet  at  any  given  date 
is  only  one  of  the  components  of  a  series  of  statements 
which,  in  the  aggregate,  exhibit  clearly  the  fortunes  of  the 
business  venture.  The  simplest  way  to  demonstrate  this  is 
to  explain  the  mechanism  of  the  double-form  balance  sheet. 

Double-Form  Balance  Sheet 

The  theory  underlying  this  form  is  to  the  effect  that 
every  enterprise  is  divided  into  two  distinct  parts : 

1.  The  financing  branch 

2.  The  operating  branch 

At  the  incipiency  of  the  enterprise,  the  financing  branch 
obtains  the  required  capital,  acquires  the  needed  assets,  and 
places  at  the  disposal  of  the  operating  branch  certain  "work- 
ing and  trading"  assets,  and  certain  "current"  (or  liquid) 
assets  free  from,  or  subject  to,  certain  "current"  liabilities. 
The  net  value  of  the  assets  thus  transferred  is  charged  to  the 
operating  branch,  and  remains  untouched  until  the  period 
for  an  accounting  has  matured.  Giving  expression  to  the 
above  in  double  balance  sheet  form,  we  obtain : 


THE    BALANCE    SHEET 
General  Balance  Sheet  of  . . . 

AT 

Financing 


4" 


Assets 

Plant  and  Machinery.  $300,000.00 

Shop  and  Hand  Tools.  20,000.00 
Shafting.  Belting,  and 

Pulleys 5,000.00 

Travelling    and    Sta- 
tionery Cranes 6,500.00 

R.    R.    Siding   and 

Equipment 3,400.00 

Flasks  and  Patterns...  1,800.00 

Patents  and  Good-Will  45,000.00 

Organization  Expense.  4,000.00 

Operating  Branch 75,000.00 


$460,700.00 


Liabilities 

Capital  Stock $400,000.00 

Real  Estate  Mortgage.      60,700.00 


$460,700.00 


Operating 


Assets 
Manufacturing  Materials  $62,ooaoo 

Sundry    Supplies 2,000.00 

Ca^h  on  Deposit 30,000.00 

Cash  on  Hand 1,000.00 

$95,000.00 


Liabilities 

Accounts  Payable $20,000.00 

Financing  Branch 75,000.00 


$95,ooaoo 


Periodical  Fluctuations  in  Double-Form  Balance  Sheet 

As  operations  progress,  the  operating  branch  transforms 
working  assets  into  current  assets,  and  current  assets  into 
working  assets;  current  liabilities  are  also  incurred  in  ex- 
change for  assets,  or  for  valuable  services.  As  a  result,  the 
operating  branch  obtains  profits  measured  by  the  excess  of 
the  increases  of  assets  plus  decreases  of  liabilities,  over  de- 
creases of  assets  plus  increases  of  liabilities. 


412  FINANCIAL    STATEMENTS 

The  profits  made  by  the  operating  branch  are  credited  to 
surplus  by  the  financing,  and  charged  to  the  operating  branch 
when  the  latter  retains  them  for  current  needs.  As  to  the 
operating  branch,  it  correspondingly  debits  Profit  and  Loss, 
in  order  to  close  that  account,  and  credits  "Financing"  from 
whom  it  has  borrowed  profits. 

If  the  profits  are  distributed  to  the  stockholders  by  the 
financing  branch,  the  account  with  the  operating  branch  is 
credited  with  the  amount  of  liquid  assets  withdrawn  from 
it  to  liquidate  the  debt.  Operating,  in  turn,  debits  the  ac- 
count with  "Financing,"  and  credits  the  asset  with  which 
it  has  parted. 

Thus,  from  period  to  period,  the  fluctuations  of  the  ac- 
count "Operating  Branch"  found  in  the  "Financing"  part 
of  the  double-form  balance  sheet,  show  the  gradual  increase 
of  the  wealth  of  the  concern. 

If  no  distribution  of  the  profits  has  taken  place,  and  if 
the  profits  have  remained  reinvested  in  the  operations,  then 
the  correlation  is  absolute.  If  the  profits  have  not  been 
distributed,  but  have  been  withdrawn  in  part  from  operations 
for  the  purpose  of  acquiring  additional  capital  assets,  the 
aggregate  amount  of  the  favorable  fluctuations  is  to  be 
found : 

1.  In  the  increase  of  the  account  "Operating" 

2.  In  the  increase  of  the  capital  assets 

both  being  measured  in  total  by  the  amount  of  the  surplus 
appearing  in  the  financing  section.  If  the  profits  have  been 
partially  distributed,  the  aggregate  of  the  profits  made  since 
the  incipiency  of  business  is  obtained  by  the  addition  of 
( I )  the  charges  to  net  profits  for  dividends,  shown  by  the 
statement  of  income;  (2)  the  increase  of  the  "operating" 
account;  (3)  the  increases  of  "capital  assets." 

Simple,  logical,  and  lucid  as  it  may  be,  the  double-form 
balance  sheet  is  seldom  used  in  America.    Its  lack  of  popu- 


THE    BALANCE    SHEET  413 

larity  is  probably  due  to  a  conviction  that  the  purpose  of  a 
balance  sheet  is  to  exhibit  financial  status  at  any  given  date, 
and  that  the  periodical  fluctuations  of  that  status  are  better 
shown  by  the  statement  of  income.  But,  whether  or  not 
the  double  form  is  used,  it  remains  true  that  its  logical  spirit 
should  influence  the  mechanism  of  all  balance  sheets. 

Opposition  of  Balance  Sheet  Items 

Whatever  may  be  the  nature  of  the  fixed  assets  acquired 
out  of  capital  contributed  and  borrowed,  they  should  be 
opposed  to  the  long-term  liabilities  to  insiders  and  to  out- 
siders, incurred  for  their  acquisition ;  and  the  same  is  true  of 
current  assets  and  of  current  liabilities.  The  status  of  the 
working  and  trading  assets  is  not  quite  so  clear.  Certain  ac- 
countants say  that  they  are  "current"  precisely  like  cash  or 
accounts  receivable,  since  they  can  be  readily  disposed  of, 
either  as  they  stand  if  they  are  trading  assets,  or  in  their  raw 
state  if  they  are  working  assets. 

It  must  be  admitted  that  if  the  financial  ease  or  distress 
of  a  concern  are  to  be  measured  by  the  correlation  existing 
between  current  assets  and  current  liabilities,  it  would  often- 
times be  unfair  to  separate  working  and  trading  assets  from 
the  current  liabilities  incurred  to  obtain  them.  It  is  probably 
for  this  reason  that  the  Interstate  Commerce  Commission 
has  done  away  with  the  terms  "Working  and  Trading" 
and  "Current,"  and  has  blended  the  two  under  the  head- 
ing "Working  Assets,"  which  it  opposes  to  "Working 
Liabilities." 

Form  of  General  Balance  Sheet 

To  illustrate  the  foregoing,  and  prepare  the  ground  for 
further  discussion,  the  following  comparative  general  bal- 
ance sheet  of  the  Black  Diamond  Manufacturing  Company 
at  December  31,  1912,  and  at  December  31,  1913,  is 
presented. 


414  FINANCIAL    STATEMENTS 

The  Black  Diamond  Manufacturing  Company 

Comparative  General  Balance  Sheet  at  December 
31,  1912,  AND  AT  December  31,  1913 

December      December  Increases 

31,  1912          31,  1913  Decreases* 
Assets  and  Deferred  Debit  Items: 
Capital  Assets: 

Land  $57,157.00      $57,i57-00     

Factory  and  Office  Buildings 70,990.44        70,990.44     

Building  Equipment 13,105.41         13,439.27  $333-86 

Power  Plant 15,90402        16,404.43  500.41 

Machinery  and  Tools 36,050.74        39,471.77  3,421.03 

■     Experimental    and    Improvement 

Plant 3,472.03          3,481.21  9.18 

Maintenance  Plant 6,218.84          6,312.06  93.22 

Printing   Plant 669.25  669.25     

Transportation   Plant 5,769.68          7,329.01  1,559.33 

Furniture  and  Fixtures 4,369.96          4.654.94  284.98 

Trade-Marks  and  Patents 2,382.78         2,692.02  309.24 


Total  Capital  Assets $216,090.15    $222,601.40      $6,511.25 


Working  and  Trading  Assets: 

Working : 

Goods  in  Process — Inventory....  $12,388.04  $10,299.68  $2,088.36 
Manufacturing  Materials  and  Sup- 
plies— Inventory   26,555.65  36,653.27  10,097.62 

Materials  for  Repairs  and  Main- 
tenance— Inventory    3,953-60  6,350.65  2,397.05 

Scrap  Material — Inventory 218.86  257.22  38.36 

Shipping  Material — Inventory 11478  220.19  105.41 

Coal,  Oil  and  Waste — Inventory..  97.00  97.30  .30 

Advertising  Matter 11,251.97  10,473.33  778.64 

Stationery  and  Printing 50.56  5570  5.14 

$54,630.46  $64,407.34  $9,776-88 
Trading : 

Finished  Goods— Inventory 56,631.05  53,651.11  2,g7g.g4 

Total  Working  and  Trading $111,261.51  $118,058.45  $6,796.94 


Total    Capital    and    Working    and 
Trading     Assets $327,351-66    $340,659.85    $13,308.19 


•  Decreases  are  shown  in  italics. 


THE    BALANCE    SHEET  415 

Comparative  General  Balance  Sheet — Continued 

December  December  Increases 

31,  1912  31,  1913  Decreases* 
Current  Assets: 

Cash  in  Banks  and  in  Office $1,865.61  $18,773.15  $16,907.54 

Special  Deposits 11,093.23  14,690.40  3,597.i7 

Notes  Receivable 1,000.00  1,000.00 

Customers'  Accounts  Receivable..       39,588.75  53,376.04  13,787.29 
Claims      against      Transportation 

Cos 529.08  732.32  203.24 

Advances  to  Employees 951-57  589.08  362.49 

Total  Current  Assets $54,028.24      $89,160.99    $35,132.75 

Deferred  Debit  Items: 

Fire  Insurance  Premiums,  un- 
expired portion $1,583.33        $1411.85         $171.48 

Freight  and  Cartage  Outward,  ap- 
plicable to  goods  finished,  ware- 
housed, and  unsold 3,670.46        3,670.46 

Total  Deferred  Debit  Items $1,583.33        $5,082.31      $3,498.98 

Total  Current  Assets  and  Deferred 
Debit   Items $55,6ii.57      $94,243-30    $38,631.73 

Total    Assets    and    Deferred    Debit 
Items  $382,963.33    $434,903.15    $51,939-92 


Liabilities  and  Surplus: 
Capital  Liabilities: 

Capital  Stock  Authorized,  Issued 
and    Outstanding $50,000.00      $50,000.00     

Real  Estate  Bond  and  Mortgage..     109,100.00        98,300.00    $10,800.00 

Total  Capital  Liabilities $159,100.00    $148,300.00    $10,800.00 

Current  Liabilities : 

Notes  and  Loans  Payable. $31,700.00      $18,749.96    $12,950.04 

Accounts  Payable: 

a.  To  Creditors 8,953.12          1,581.79       7,37 1-33 

b.  "    Employees  —  Wages   Ac- 

crued      774-82        10,717.24       9,94242 


*  Decreases  are  shown  in  italics. 


^j5  financial  statements 

G)MPARATiVE  General  Balance  Sheet — Continued 

December      December     Increases 
31,  1912  31,  1913       Decreases* 

c  To  Salesmen — Salaries,  Com- 
missions and  Expenses        1,182.20         3.588.19       2405.99 

d.  "    Employees — Profit    Shar- 

ing Scheme 9,689.28  73479        8,954.49 

e.  "   Employees — Deposits   for 

Use  of  Tools 10.75  63.58  52.83 

f.  "    State— For   Taxes 1,116.12        1,116.12 

Total   Current  Liabilities $52,310.17      $36,551-67    $15,758-50 

Total  Liabilities $211,410.17    $184,851.67    $26,558.50 

Surplus: 

a.  Appropriated: 

For  Reserves  for  CI  a i  m i 
against  Transportation 
Companies   $184.75  $569-73         $38498 

For  Reserves  for  Deprecia- 
tion of  Physical  Assets 9,481.39       9,481.39 

For  Possible  Losses  of  Ac- 
counts Receivable 2,715.34       2,715.34 

Total  Appropriated $184.75      $12,766.46    $12,581.71 

b.  Available  for  Dividends 171,368.31      237,285.02      65,916.71 

Total  Surplus $i7i,553-o6    $250,051.48    $78498.42 

Total  Liabilities  and  Surplus $382,963.23    $434,903:15    $51,939.92 

*  Decreases  are  shown  in  italics. 

Attention  is  called  to  the  fact  that  the  apparent  differ- 
ences in  handling  the  facts  of  the  two  periods  covered  by 
these  balance  sheets,  are  due  to  a  change  of  accounting 
policy.t 

Reading  a  Balance  Sheet 

The  reading  of  a  balance  sheet  depends,  of  course,  upon 
the  way  the  facts  are  presented.    In  the  foregoing  example, 

t  See  reserves,  Chapter  XXIV,  and  deferred  debit  items,  Chapter  XXVI. 


THE    BALANCE    SHEET 


417 


it  is  plain  that,  as  between  the  beginning  of  operations  and 
the  closing  date  of  the  last  period,  $340,659.85  of  capital 
and  working  and  trading  assets  have  been  obtained  out  of 
$148,300.00  of  capital  liabilities,  and  that  $94,243.30  of 
current  assets  and  deferred  debit  items  have  been  obtained 
out  of  $36,551.67  of  current  liabihties.  Thus,  the  excess 
of  capital  assets,  $192,359.85  (including  working  and  trad- 
ing assets),  over  the  capital  liabilities,  and  the  current  assets, 
$57,691.63  (including  deferred  debit  items),  must  in  the 
aggregate,  represent  reinvested  profits  as  measured  by  sur- 
plus in  its  two  components,  ( i )  appropriations  for  reserves, 
(2)  available  for  distribution.  Correspondingly,  it  is  evi- 
dent that  as  between  the  two  periods  ended  December  31, 
1912,  and  December  31,  1913,  the  aggregate  of  the  increase 
of  capital  assets,  $13,308.19  (including  working  and  trad- 
ing assets),  and  of  the  decrease  of  capital  liabilities,  $10,- 
800.00,  or  altogether  $24,108.19;  and  the  aggregate  of  the 
increase  of  other  assets,  $38,631.73,  and  of  the  decrease  of 
current  liabilities,  $15,758.50,  or  altogether  $54,390.23, 
represent  a  sum  of  $78,498.42  which  must  give  the  increase 
of  surplus  of  the  last  period  over  the  preceding  one. 


CHAPTER  XXXVI 

SPECIAL  FORMS  OF  BALANCE  SHEETS 

Bank  Balance  Sheet 

The  classification  of  the  balance  sheet,  as  suggested  in 
the  preceding  chapter,  does  not  apply  to  financial  corpora- 
tions, insurance  companies,  and  public  utilities  corporations, 
regulated  by  the  Interstate  Commerce  Commission  or  by 
public  service  commissions.  The  classification  of  the  balance 
sheet  of  a  bank  is  indicated  by  the  purpose  of  the  institu- 
tion itself,  considered  in  connection  with  the  purpose  of  the 
depositor.  The  purpose  of  the  bank  is  to  invest  the  money 
intrusted  to  it  by  depositors,  or  to  hold  it  in  reserve,  subject 
to  call,  in  exchange  for  a  compensation  which  represents  the 
diflference  between  the  earnings  of  the  depositor's  funds,  and 
the  amount  of  such  earnings  as  the  depositor  is  wilHng  to 
accept  under  the  form  of  interest,  together  with  the  expenses 
of  conducting  the  enterprise. 

The  purpose  of  the  depositor  is  to  place  his  money  in  a 
safe  place,  to  receive  interest  on  his  deposits,  and  to  simplify 
means  of  exchange  by  issuing  orders  upon  the  bank  to  remit 
to  others  or  to  pay  to  him  such  funds  as  he  wishes  to  with- 
draw. It  follows  that  the  all-essential  thing  in  the  balance 
sheet  of  a  bank  is  to  arrange  the  assets  so  as  to  show : 

1.  The  investments  of  diflferent  nature,  required  by  law 

or  otherwise,  which,  while  liquid  in  principle,  are 
not  as  yet  converted  into  cash. 

2.  The  specie,  legal  tender  notes,  certificates  of  deposit, 

held  ready  for  payment  over  the  counter. 

418 


SPECIAL    FORMS    OF    uALANCE    SHEETS  419 

3.  The  other  assets  of  the  bank  acquired  by  the  direc- 
torate out  of  capital  contributions  or  out  of  profits 
accumulated  for  reinvestment. 
As  to  the  liabilities,  if  there  ever  is  a  reason  for  bringing 
in  the  liabilities  to  outsiders  before  the  liabilities  to  stock- 
holders, that  reason  is  to  be  found  in  the  balance  sheet  of  a 
bank.    That  banks  do  not  always  reason  as  accountants  do, 
is  evidenced  by  the  following  balance  sheet  which  gives  the 
form  used  by  a  national  bank  of  New  York  City.     This 
shows  the  bank  buildings  and  fixtures  before  the  cash  re- 
sources of  the  bank,  and  the  capital  stock  before  the  liabilities 
to  depositors. 

Balance  Sheet  of  National  Bank 
Resources 

Loans  and  Discounts $3,340,988.75 

Bills  Discounted : 

Single  Name $836,434.00 

Double  Name 490,191.13 

Collateral  Loans 469,810.00    $1,796435.13 

Demand  Loans : 

Secured  by  Collateral $692,604.47 

Not  Secured 63,306.90         755.91 1.37 

Time  Loans 663,500.00 

($177,500  of  these  are  hypothecated.) 

Foreign  Bills 89,936.65 

Past-Due  Paper 35,205.60 

U.  S.  Bonds  and  Premium 30i,437-50 

U.  S.  Bonds  for  Circulation   $250,000.00 

U.  S.  Bonds  for  Deposits 50,000.00 

Premium  on  September  15,  1913 1437.50 

Investments  280,989.32 

Florida  Transportation  Co.  Bonds $17,600.00 

Second  Mortgage  on  Real  Estate 6,500.00 

Milltown  Mining  and  Brick  Bonds 20.000.00 

17th  Avenue  Property i44,59i-99 

ist  Avenue  Property 42,297.33 

Long  Island  Sound  Tunnel  Bonds 50,000.00 


420 


FINANCIAL    STATEMENTS 


Balance  Sheet — Continued 


Bank  Buildings  and  Fixtures 118,799.95 

Land  and  Building $106,011.45 

Furniture 12,788.50 

Due  from  Banks 233,651.50 

Twelfth  National  Bank $159,751.20 

Twentieth  Century  Bank 31,634.88 

East  Side  National  Bank 20,095.12 

Bank  of  Newton 7,340.22 

West  End  Bank 3,138.88 

Sundry  Checks  out  for  collection 1 1,691.20 

Cash  and  Reserve 971,616.44 

Cash  (See  report  for  particulars) $516,950.35 

Cash  deposited  with  U.  S.  Treasurer  for 

Redemption  Fund 25,000.00 

First  National  Bank 203,890.11 

Tenth  Avenue  National  Bank 122,535.58 

German  National  Bank 103,240.40 

$5,247,483.46 

Liabilities 

Capital  Stock $350,000.00 

3,500  shares  of  $100  each,  fully  paid. 

Surplus  515,000,00 

Balance  of  Surplus.  November  15,  1912..       $500,000.00 
Added  from   Profit  during  year  to  No- 
vember 15,  1913 15,000.00 

Undivided  Profits 51.332.85 

Balance  of  Account,  November  15,  1912. .         $49,894.07 
Profit  for  year  ended  November  15,  1913  40,238.78 

Less :  $90,132.85 

Dividends  Paid $23,800.00 

Transferred  to  Surplus 15,000.00  38,800.00 

Balance  of  Account $51,332.85 

Circulation 248,300.00 

Authorized  Circulation $250,000.00 

Deduct  Circulation  held  by  Comptroller..  1,700.00 


SPECIAL    FORMS    OF    BALANCE    SHEETS  421 

Balance  Sheet — Continued 

Due  Other  Banks I97.97S.5I 

Twentieth  Century  Bank $163,824.49 

Twelfth  National  Bank 23,615.80 

Bank  of  Oldtown 10,535.22 

Bills  Payable  ( Secured) 177,500.00 

(Due  to  other  national  banks — secured  by 
time  loans  hypothecated.) 

Dividend  Checks  Not  Presented 1,200.00 

Deposits  3,706.175.10 

Individual $3,507,085.07 

Certified  Checks 9,071.48 

Cashiers'  Checks 36,129.48 

Certificates  of  Deposit 52409.07 

Transient  Collections 615.00 

United  States  Deposit 100,000.00 

Teller's  Due  Bills 865.00 

$5,247483.46 


The  Balance  Sheet  of  Life  Insurance  Companies 

The  form  of  the  balance,  sheet  required  of  life  insurance 
companies  by  the  Insurance  Department  of  the  State  of  New 
York  is  given  here  in  full  detail.  It  follows  the  proof  of 
ledger  assets,  reference  to  which  has  been  made  in  the  fore- 
going. It  is  especially  interesting  because  it  divides  assets 
into: 

a.  Ledger  Assets 

b.  Non-Ledger  Assets 
2.  Assets  not  admitted,  which  must  be  deducted  from 

the  sum  of  all  the  assets  in  order  that  the  truly 
available  funds  may  be  ascertained. 
The  term  "Non-Ledger  Assets"  does  not  refer,  as  one 
accountant  said  in  scorn,  to  assets  owned  but,  for  some  un- 
known and  discreditable  reason,  not  placed  on  the  books; 
but  to  assets  accrued  which  may  not  be  on  the  books  at  any 
time  other  than  the  end  of  the  calendar  year,  if  such  is  the 
policy  of  the  concern. 


! 


Form  of  Balance  Sheet  of  Life  Insurance  Company 

AS  Prescribed  by  the  Superintendent  of 

Insurance,  State  of  New  York 


1. 

2. 
3. 
4. 

5. 

6. 
7. 
8. 

9. 

10. 
11. 
12. 


1£DGEB   ASSETS 

Booh  value  of  real  Estate,  per  Scnedule  A 

Mortgace  loaiiis  on  real  estate,  per  Schedule  B.  first  liens,  $....;  other 
than     first     liens,     $ ;     

Loans    secured    by    pledge    of    bonds,    stocks    or    other    collateral,    per 
Schedule    C 

Loans  made  to  policyholders  on  this  company's  policies  assigned  aa  col- 
lateral     

Premium   notes  on  policies  In   force,   of   which   $ is  for  first   year's 

premiums    

Booh  value  of  bonds.  $ ;  and  stochs.  $ ;  per  Schedule  D 

Cash    in    company's    ofllce $ 

Deposits   In   trust   companies   and   banks,   not   on   Interest,    per 
Schedule    E 

Deposits    in    trust    companies    and    banks,    on    Interest,    per 
Schedule   E 

BUla   reoelTable,   $. 
net,  $....;   


•cents'    balances   (debit.   I....:   credit,   $. 


.); 


Total  Ledier  AMets,  as  per  "balanes"  on  page  3 


13. 
14. 
15. 

16. 

,17. 

18. 
19. 
20. 

21. 
22. 
23. 


Interest  due,  S... 
Interest  due,  $. .. 
Interest  due,   $. . 

C,    Part    1 

Interest  due,  $.. 

or  liens   

Interest    due,    $. 

and  amounts) : 


NON-LEDGER  ASSETS 

. .;  and  accrued,  $ on  mortgages,  per  Schedule  B. . 

.   and  accrued,  $ on  bonds,  per  Schedule  D,  Part  1 

. .    and  accrued,  $ on  collateral  loans,  per  Schedule 


and  accrued,  %. 


on  premium  notes,  policy  loans 


and    accrued,    $. 


on    other    assets    (give    Items 


Rents  due.  $....   and  accrued,  S on  company's  property  or  lease.... 

Total  interest  and  rents  due  and  accrued 

Market  value  of  real  estate  ever  book  value,  per  Schedule  A 

Market  value   (not   Including   Interest  in  Item   14),  of  tx>nds   and  stoclia  over  book 

value,    per   Schedule   D 

Due   from  other  companies  for  losses   or  claims  on  policies   of  this   company,   re- 
insured     


Gross  premiums  due  and  unreported  on  policies  in  force  Decem- 
ber  31,    1912    (less   reinsurance   premiums) 

Gross  deferred  premiums  on  policies  In  force  December  31, 
1912    (less   reinsurance  premiums) 


(1)  New 
Business 


/$• 


Deduct    loading > 

Net   amount  of  uncollected  and  deferred  premiums. 


Totals 


„    <2) 
Renewals 


30.   AH  other  assets  (give  Items  and  amounts): 
81 « 


33. 
34. 


GroM  Asset*. 


39. 
40. 
41. 

42. 
43. 
44. 
45. 


DEDUCT    ASSETS    NOT    ADMITTBD 

Company's  stock  owned  $ ;  loans  on  $....;    ~f7 

SuppUes,  stationery,   printed  matter,  $....;  furniture,   fixtures   and   safes. 


Commuted  commissions,  $ ;  agents'  debit  balances,  gross,  $ ;   .... 

Cash   advanced  to  or  in  the  hands  of  officers  or  agents 

Loans  on  personal  security,  endorsed  or  not,  $ ;  bills  receivable,  $ 

Premium   notes   and  loans  on   policies   and  net  premiums  In   Item  29  In 

excess   of  net   value   of   their   policies 

Overdue  and  accrued  Interest  on  bonds  in  default 

Book   value  of   Ledger  Assets  over   market  value,   via.: 


Admitted  Aesets $ 


lilABTUTIES.  SURPLUS  AND  OTHER  FUNDS 
Aet  present  value  of  all  the  outstanding  policies  in  force  oo  the  31st 

day  of  December,  1912,  as  computed  by  the 

on  the  following  tables  of  mortality   and  rates  of  Interest,  viz.: 
1.    Actuaries'   table   al per  cent,   on* 


Same  for  reversionary   additions 

2.    American  Experience  table  at....   pet  cent.   on*. 


Same  for  rerersionary   additions 

S.    American  Experience  table  at.... per  cent,  on* 


Same  for  reversionary   additions. 
4.    Other  tables  and  rates,  viz.  :* 


Same  for  reversionary   additions. 


6.    Net  present  value  of  annuities   (including  those  In  reduction  of 
premiums).     Give  tables   and  rates  of  Interest,  viz. : 


Total    

Deduct   net  value   of   risks   of   this  company   reinsured   In   other   solvent 
companies    


7.    Reserve  to  provide  for  health  and  accident  benefits  contained  In  life  policies 


Net    Reserve    (Pald-for   basis) 

Present   value   of    amounts   not   yet    due   on   supplementary   contracts   net 

involving    life    contlnKencies,    computed    by    the 

Liability   on   policies  cancelled   and   not   Included  in    "net  reserve"   upon 

which    a   surrender  value   may    bo  demanded 

Claims  for  death   losses  due   and   unpaid 

Claims  for  death  losses  In  process  of  adjustment,  or  adjusted  and  not  due 
Claims  for  death   losses  incurred  for  which   no  proofs  have   been  received 

Claims   for   matured    endowments    due    and    unpaid 

Claims  for  death  losses  and  other  policy  claims  resisted  by  the  company 
Due  and   unpaid   on   annuity   claims   involving   life   contingencies 


Total   Policy    Claims. 


18. 
19. 

20. 
21. 
22. 
23. 
24. 

25. 
26. 
27. 

28. 
89. 
30. 
31. 

82. 


34. 


Due  and  unpaid  on  supplementary  contracts  not  involving  life  contingencies 

Dividends  left  with  the  company  to  accumulate  at  interest,  and  accrued  interest 
thereon    

Premiums   paid   in    advance,   including  surrender  values   so   applied 

Unearned   interest   and   rent   paid   in    advance 

Commissions  due  to  agents  on  premium  notes  when  paid 

Commissions    to    agents,    due    or    accrued 

"Cost  of  collection"  on  uncollected  and  deferred  premiums.  In  excess  of  the  loading 
thereon 

Salaries,   rents,   oflflce  expenses,   blUs  and   accounts  due   or  accrued 

Medical   examiners'   fees   $ and   legal   fees   $ due   or   accrued 

Estimated  amount  hereafter  payable  for  federal,  state,  and  other  taxes  based  upon 
the   business  of  the  yea^   of  this  statement 

Advances  by  officers  or  others  on   account  of  expenses  of  organization  at  otherwise 

Borrowed  money  $. . . .   and  Interest  thereon  $ ;   

Unpaid    dividends   to   stockholders 

Dividends  or  other  profits  due  iwlicyholders,  including  those  contingent  on  payment 
of  outstanding  and  deferred  premiums 

Dividends  declared  on  or  atH'ortioned  to  annual  dividend  policies  payable  to  policy- 
holders during  1913,  whether  contingent  upon  the  payment  of  renewal  pre- 
miums  or   otherwise 

Dividends  declared  on  or  apportioned  to  deferred  dlvMend  policies  payable  to 
policyholders  during  1913 

Amounts  set  apart,  apportioned,  provlaionally  ascertained,  calculated,  declared  or 
held  awaiting  apportionment  upon  deferred  dividend  policies,  not  included  in  Item 
33    

Beserve,  special  or  surplus  funds  not  included  above  (give  items  and  amounts  sepa- 
rately,   and   state   for   what   purpose   each   of   said   funds   is   held): 


AU  other  liaUUties  (give  items  and  amounts): 


44.  Capital   stock 

45.  Unasslgned   funds    (surplus). 


Total. 


'State  definitely  the  dates  of  Issue  and  class  of  policies  covered  by  each  basis  of 
valuation. 


424  FINANCIAL    STATEMENTS 

Balance  Sheet  of  Steam  Roads  Engaged  in  Interstate  Com- 
merce 
The  form  presented  here  is  nothing  more  than  the  ex- 
pression of  the  requirements  of  the  Interstate  Commerce 
Commission,  as  formulated  in  their  pamphlet  (first  revised 
issue  effective  June  15th,  1910)  entitled  "General  Balance 
Sheet  Statements  as  prescribed  by  the  Interstate  Commerce 
Commission  for  Steam  Roads,  in  accordance  with  Section 
20  of  the  Act  to  regulate  Commerce." 

Balance  Sheet  Statement 
Assets 

Property  Investment: 
I.  Road  and  Equipment: 
Bia  Investment  to  June  30,  1907: 

Road $ 

Equipment 

Bib  Investment  since  June  30,  1907 : 

Road  

Equipment 

General  Expenditures 

Total  Road  and  Equipment $ 

Bic  Reserve  for  Accrued  Depreciation  (Cr.) 

Total  Road  and  Equipment $ 

II.  Securities: 

B2  Securities  of  Proprietary,  Affiliated,  and 

Controlled  Companies — Pledged $ 

B3  Securities  Issued  or  Assumed — Pledged 

B4  Securities  of  Proprietary,  Affiliated,  and 

Controlled  Companies — Unpledged 

Total   Securities $ 

III.  Other  Investments : 

Bs  Advances  to  Proprietary,  Affiliated,  and 
Controlled  Companies  for  Construc- 
tion, Equipment,  and  Betterments $ 


SPECIAL    FORMS    OF    BALANCE    SHEETS 

Balance -Sheet  Statement — Continued 

B6  Miscellaneous  Investments: 

Physical  Property 

Securities — Pledged 

Securities — Unpledged   


425 


Total  Other  Investments. 


Total  Property  Investment $. 

Working  Assets: 

B7  Cash $ 

B8  Securities  Issued  or  Assumed — Held  in 

Treasury : 

Stocks  

Funded  Debt 

Miscellaneous 

B9  Marketable  Securities: 

Stocks 

Funded  Debt 

Miscellaneous 

Bio  Loans  and  Bills  Receivable 

Bii  Traffic   and   Car   Service   Balances   Due 

from  Other  Companies 

B12            Net  Balance  Due  from  Agents  and  Con- 
ductors   

B13  Miscellaneous  Accounts  Receivable 

B14            Materials  and  Supplies  (Depreciation  de- 
ducted)     

B15  Other  Working  Assets 


Total  Working  Assets. 


Accrued  Income — Not  Due: 
B16            Unmatured     Interest,     Dividends,     and 
Rents  Receivable 


Deferred  Debit  Items: 
B17  Advances : 

Temporary   Advances   to   Proprietary, 
Affiliated,  and  Controlled  Companies  $. 

Working  Funds 

Other  Advances 

B18  Rent  and  Insurance  Paid  in  Advance 

B19  Taxes  Paid  in  Advance 


426 


FINANCIAL    STATEMENTS 


Balance  Sheet  Statement — Continued 


Bao  Unextinguished  Discount  on  Securities: 

On  Capital  Stock 

On  Funded  Debt 

Bai  Property  Abandoned,  chargeable  to 
Operating  Expenses 

B22.  Special  Deposits 

B23  Cash  and  Securities  in  Sinking  and  Re- 
demption Funds 

B24  Cash  and  Securities  in  Insurance  and 
Other  Reserve  Funds 

B25  Cash  and  Securities  in  Provident  Funds. . 

B26  Other  Deferred  Debit  Items 

Total  Deferred  Debit  Items 

Profit  and  Loss: 
B27  Balance 


Total $. 

Liabilities 

Stock: 
Ba&  Capital  Stock: 

Held  in  Treasury: 

Common  Stock $ 

Preferred  Stock 

Debenture  Stock 

Total $ 

Issued  and  Outstanding: 

Common  Stock $ 

Preferred  Stock 

Debenture  Stock ! . . . . 

Receipts  Outstanding  for  Instalments 
Paid 

Total $ 

Bap            Stock  Liability  for  Conversion  of  Securi- 
ties of  Constituent  Companies $ 

B30  Premiums  Realized  on  Capital  Stock 

Total  Stock $. 


SPECIAL    FORMS    OF    BALANCE    SHEETS  427 

Balance  Sheet  Statement — Continued 

Bonded  Mortgage  and  Secured  Debt: 
B31  Funded  Debt : 

Held  in  Treasury: 

(a)  Mortgage  Bonds $ 

(b)  Collateral  Trust  Bonds 

(c)  Plain    Bonds,    Debentures,    and 

Notes    

(d)  Income  Bonds 

(e)  Equipment  Trust  Obligations 

(f)  Miscellaneous    Funded    Obliga- 

tions     


Total $. 


Issued  and  Outstanding: 

(a)  Mortgage   Bonds $. 

(b)  Collateral  Trust  Bonds 

(c)  Plain    Bonds,    Debentures,    and 

Notes 

(d)  Income  Bonds 

(e)  Equipment  Trust  Obligations 

(£)    Miscellaneous    Funded    Obliga- 
tions     

(g)  Receipts  Outstanding  for  Funded 
Debt  


Total $. 


832  Receivers'  Certificates $. 

B33  Obligations  for  Advances  Received  for 
Construction,  Equipment,  and  Better- 
ments   


Total  Bonded  Mortgage  and  Secured  Debt. 

Working  Liabilities: 

B34  Loans  and  Bills  Payable $ 

B35  Traffic  and  Car  Service  Balances  Due  to 

Other  Companies 

B36  Audited  Vouchers  and  Wages  Unpaid 

B37  Miscellaneous  Accounts  Payable 

B38  Matured  Interest,  Dividends,  and  Rents 

Unpaid 


428 


FINANCIAL    STATEMENTS 
Balance  Sheet  Statement — Continued 


B39  Matured  Bonded  Mortgage  and  Secured 
Debt  Unpaid 

B40  Working  Advances  Due  to  Other  Com- 
panies   

B41  Other  Working  Liabilities 

Total  Working  Liabilities 


Accrued  Liabilities — Not  Due: 
B42  Unmatured     Interest,      Dividends,     and 

Rents  Payable 

B43  Taxes  Accrued 


Total  Accrued  Liabilities. 


Deferred  Credit  Items: 
B44            Unextinguished  Premiums  on  Outstand- 
ing Funded  Debt 

B45  Operating  Reserves 

B46             Liability  on  Account  of  Provident  Funds 
B47  Other  Deferred  Credit  Items 


Total  Deferred  Credit  Items. 


Appropriated  Surplus: 
B48  Additions  to  Property  since  June  30,  1907, 

through  Income 

B49  Reserves  from  Income  or  Surplus: 

Invested   in    Sinking   and    Redemption 

Funds  

Invested  in  Other  Reserve  Funds 

Not  Specifically  Invested 


Total  Appropriated  Surplus. 


Profit  and  Loss: 
B50  Balance  .. 


Total $. 


In  departing  from  generally  accepted  accounting  classifi- 
cations, the  commission  has  fulfilled  excellently  its  purpose, 
which  was  to  control  the  presentation  of  facts  by  steam 
roads  so  that  it  would  be  possible  to  judge  them  all  accord- 


SPECIAL    FORMS    OF    BALANCE    SHEETS 


429 


ing  to  the  same  standard.  The  distinctions  made  between 
working  assets  and  deferred  debit  items  are  at  times  a  trifle 
academic,  and  it  is  not  always  easy  to  explain  the  reason 
why  certain  facts  should  be  in  one  group,  while  other  facts 
apparently  similar  in  every  respect  are  to  be  found  in  an- 
other group.  Generally  speaking,  however,  it  may  be  said 
with  propriety  that  the  commissions'  requirements  have  re- 
flected a  great  amount  of  light  upon  the  real  value  of 
financial  facts  which,  in  the  past,  were  included  in  groups 
created  to  act  as  deflectors  or  as  screens. 

The  balance  sheet  of  public  utility  corporations  which 
are  under  the  control  of  the  various  public  service  commis- 
sions created  by  the  states  of  the  Union,  will  not  be  found  to 
differ  greatly  in  spirit  from  the  form  given  above  for  steam 
roads  regulated  by  the  Interstate  Commerce  Commission, 
They  may,  however,  adopt  a  dififerent  terminology  and  per- 
haps, in  a  few  instances,  somewhat  alter  the  requirements 
of  the  different  groups.  The  powers  of  the  said  commissions 
in  connection  with  uniform  systems  of  accounting  can  only 
be  obtained  from  the  statutes  creating  them,  or  from  amend- 
ments thereto  brought  about  by  the  recommendations  of  the 
commissions  themselves  in  their  report  to  the  state 
legislatures. 


CHAPTER  XXXVII 

THE  STATEMENT  OF  INCOME  AND  PROFIT 
AND  LOSS 

Elements  of  Statement 

Speaking  of  a  business  enterprise  as  an  abstract  proposi- 
tion, the  result  of  operations  discloses :  operating  profits, 
operating  losses,  expense,  profit  and  loss  charges,  profit  and 
loss  credits,  income  from  sources  other  than  operations ;  de- 
ductions from  income  and  profits ;  adjustments  of  profits  or 
losses  of  prior  periods. 

"Operating  Profit"  is  that  part  of  the  trading  capital 
sent  out  which  has  returned  in  excess  of  the  value  of  the 
outgo. 

"Operating  Loss"  is  that  part  of  the  trading  capital  sent 
out  which  has  not  returned  and  will  not  return. 

"Expense"  is  that  part  of  the  invested  capital  which 
must  be  given  up  in  exchange  for  such  services  as  the  busi- 
ness requires. 

"Profit  and  Loss  Charges"  are  losses  of  capital  incurred 
in  a  particular  accounting  period  otherwise  than  through 
operations;  they  are  due  to  the  sale  of  non-trading  assets 
below  the  cost  thereof;  to  inefficiency,  carelessness, 
malignity,  or  dishonesty  of  employees,  or  to  natural  causes 
over  which  the  administration  has  no  control. 

"Profit  and  Loss  Credits"  are  gains  of  capital  made  in  a 
particular  accounting  period  otherwise  than  through  opera- 
tions or  through  the  regular  and  expected  earnings  of  in- 
vested values. 

430 


STATEMENT    OF    INCOME  431 

"Income  from  Sources  Other  Than  Operations"  repre- 
sents the  earnings  of  capital  invested  otherwise  than  to 
satisfy  the  requirements  of  the  basic  business  purpose. 

"Deductions  from  Income  and  Profits"  are  the  part  of 
his  income  and  profits  which  the  business  man  must  share 
with  others  for  the  use  of  their  wealth  in  the  conduct  of  his 
business,  or  must  pay  to  others  as  a  compensation  for  the 
safeguards  with  which  they  surround  his  business  interests. 

"Surplus  or  Capital  Adjustments"  represent  the  changes 
which  must  be  made  in  the  net  results  of  the  operations  of 
past  periods  in  order  that  conditions  unknown  then,  but  now 
understood,  may  not  erroneously  affect  the  results  of  the 
prior  period. 

When  attempting  to  express  the  causes  which  have 
brought  about  operating  profits  or  operating  losses,  it  is 
necessary  to  state : 

1.  The  amount  of  the  values  which  have  come  in,  in 

exchange  for  the  values  which  have  gone  out 

2.  The  amount  of  the  values  which  have  gone  out  in  ex- 

change for  the  values  which  have  come  in 

Non-trading  concerns  call  the  first  group  of  facts  re- 
ceipts, revenue,  operating  earnings,  or  any  name  which 
applies  unequivocally  to  the  particular  operations  of  the 
enterprise. 

Trading  concerns  as  well  as  manufacturing  concerns  en- 
gaged in  trading,  oppose  sales  to  the  cost  of  the  goods  sold. 
Accountants  have  taken  the  habit  of  calling  sales  "income 
from  sales,"  and  deductions  therefrom,  "deductions  from 
income  from  sales." 

They  have  been  led  to  this  harmless  distortion  of  the 
meaning  of  the  word  "income"  by  the"  praiseworthy  desire 
of  giving  to  the  statement  to  be  presented  by  them  an 
anatomical  aspect  suggestive  of  logic,  clarity,  and  analytical 
power. 


432  FINANCIAL    STATEMENTS 

The  marshaling  and  the  grouping-  of  the  various  ele- 
ments which  constitute  the  sundry  classes  of  financial  facts 
indicated  in  the  foregoing,  is  the  purpose  of  the  "Statement 
of  Income  and  Profit  and  Loss." 

Mechanism  of  Statement 

The  mechanism  of  the  "Statement  of  Income  and  Profit 
and  Loss"  is  simplicity  itself ;  it  is  as  follows : 

1.  The  income  from  operations  is  given  at  its  gross 
figure.  From  that  gross  figure  are  deducted  all  the  items 
which  have  reduced  it,  either  through  cancellation  of  the 
original  transactions,  or  through  partial  reductions  thereof, 
or  again  through  expenditures  which  were  positively  in- 
cluded in,  and  deductible  from,  the  amount  receivable  from 
operations  in  accordance  with  the  expressed  or  implied 
terms  of  the  contract  which  made  them  possible. 

2.  The  cost  of  obtaining  that  income,  i.e.,  the  operating 
cost,  is  given  next,  in  order  that  by  its  deduction,  the  gross 
profit  represented  by  the  excess  of  the  returns  over  cost  may 
be  gauged. 

3.  The  cost  of  bringing  about  the  conditions  which  made 
operations  possible  follows.  When  this  is  deducted  the  re- 
sult, in  mercantile  as  well  as  in  manufacturing  concerns,  is 
known  as  the  selling  profit. 

4.  If  from  the  selling  profit,  the  cost  of  administering 
the  business  is  deducted,  the  resulting  figure  is  the  net 
income,  or  the  profit  from  operations. 

5.  To  this  profit  is  added  the  income  obtained  from  other 
sources. 

6.  From  the  sum  of  sections  4  and  5,  there  is  deducted 
the  voluntary  or  unavoidable  sharing  of  income  and  profits 
with  others  who  lend  their  financial  or  their  protective 
assistance  to  the  business. 

7.  8.  To  the  remainder,  the  profit  and  loss  credits  are 


STATEMENT    OF    INCOME 


433 


added,  and  from  the  remainder  the  profit  and  loss  charges 
are  deducted. 

9.  The  result  is  the  net  profit  from  all  sources,  for  the 
period. 

10.  From  this  net  profit  there  is  to  be  deducted  appropria- 
tions for  contingencies  of  the  future,  that  is  to  say,  pro- 
visions for  reserves. 

1 1.  To  this  result  there  must  be  added  the  undivided  pro- 
fits of  the  prior  periods,  adjusted  by  adding  thereto,  or  de- 
ducting therefrom,  the  losses  maturing  during  the  present 
period  and  denying  gains  taken  as  such  in  a  prior  period 
(or  vice  versa  if  conditions  are  reversed). 

12.  The  result  is,  of  necessity,  the  amount  of  undivided 
profits  known  as  "surplus"  in  corporate  balance  sheets,  and 
stated  at  the  same  figure  by  the  statement  showing  the 
financial  status.  If  the  concern  is  a  sole  proprietorship,  or 
a  copartnership,  the  result  of  section  10  is  added  to  the 
capital  accounts  of  the  proprietors  adjusted  as  suggested  in 
section  11.  The  result,  then,  is  the  actual  equity  of  the 
proprietors  in  their  assets,  as  expressed  by  the  balance  sheet. 

The  following  statement  of  income  and  profit  and  loss 
of  the  Black  Diamond  Manufacturing  Company*  will  serve 
as  an  illustration : 

The  Black  Diamond  Manufacturing  Company 

Statement  of  Income  and  Profit  and  Loss 
FOR  THE  Year  Ended  December  31,  1913 

« Income  from  Sales: 

Gross  Sales $788,96841 

Less  Returns 343417 

Net  Sales.... $785,534.24 


*  Sec  balance  sheet  given  in  Chapter  XXXV. 


424  FINANCIAL    STATEMENTS 

Statement  of  Incx)me — Continued 

Deductions  from  Sales : 

Allowances  to  Customers: 

On  Sale  Price $380.10 

On  Damaged  Goods 276.04 

Freight  and  Cartage  Outward — on  Sales 40,300.00 

Stable  and  Automobile  Expense — Proportion 
Applicable  to  Sales 7,851.68 

Total  Deductions  from  Sales $48,807.82 

Income  from  Sales $736,726.42 

Cost  of  Goods  Sold: 

Manufacturing  Cost  of  Goods  Finished  During  the  Period : 
Prime  Cost: 
Materials  and  Supplies  Consumed — Includ- 
ing Freight  and  Cartage  thereon $295,379.01 

Productive  Labor 55,316.83 

Total  Prime  Cost $350,695.84 

Manufacturing  Overhead: 

Superintendence $7,370.49 

Unproductive  Labor 8,221.40 

Heat,  Light,  and  Power 3,677.82 

Factory  Expense 8405.06 

Repairs  and  Maintenance,   Machinery  and 

Tools 5,120.09 

Total  Manufacturing  Overhead $32,794.86 

General  Factory  Overhead : 

Salaries  and  Wages — Shipping  Department  $7,982.36 

Shipping  Material  Consumed 1,114.77 

Shipping  Department   Supplies 9.21 

Miscellaneous  Shipping  Expense 447-86 

Traveling  Expense — Shipping  Department..  275.21 
Stationery     and     Printing     Consumed     by 

Factory   7.53 

Total  General  Factory  Overhead $9,836.94 

Total  Manufacturing  Cost  for  the  Period $393,327.64 

Deduct :  Increase  of  Inventory  of  Goods  in 
Process  as  between  January  i  and  De- 
cember 31,  1913 ^ 


STATEMENT    OF    INCOME 


Statement  of  Income — Continued 


435 


Add:  Decrease  of  Inventory  of  Goods  in 
Process  as  between  January  i  and  Decem- 
ber 31,  1913 2,088.36 


Manufacturing  Cost  of  Goods  Finished  Dur- 
ing the  Period $395416.00 

Inventory  Adjustment: 

Deduct :  Increase  of  Inventory  of  Finished 
Goods  as  between  January  i  and  December 
31,  1913,  after  deduction  therefrom  of  the 
value  of  goods  distributed  free,  and  used 
by  salesmen 7,954-59 

Add :  Decrease  of  Inventory  of  Finished 
Goods  as  between  January  i  and  Decem- 
ber 31,  1913,  after  deduction  therefrom  of 
the  value  of  goods  distributed  free,  and 
used  by  salesmen 

Manufacturing  Cost  of  Goods  Sold $387,461.61 

Additional  Cost — Freight,  Handling  and  Ware- 
housing of  Raw  Materials  Consumed 4,905.27 

Total  Cost  of  Goods  Sold 392,366.88 

Gross  Profit  on  Sales $344,359-54 

Selling  Expense: 

Salaries  of  Selling  Management ' $6,099.12 

Salaries,     Commissions,     and     Expenses     of 

Salesmen 128,650.42 

Advertising   Expense 12,033.28 

Free  Goods 33,428.14 

Traveling  Expense  of  Sales  Manager 1,079.67 

Premiums 1,954.86 

Stationery  and  Printing  Consumed  by  OfHce 

of  Sales  Manager 416.21 

Special  Inducements  to  Jobbers 2,ioa9S 

Salesmen's  Samples  used  in  demonstration...  7,537.88 

Sundry  Expense  of  Sales  Office 297.54 

Total  Selling  Expense I93,S98.07 

Selling  Profit $150,761.47 


436 


FINANCIAL    STATEMENTS 


Statement  of  Income — Continued 

Administrative  and  General  Expenses: 

Administrative : 

Office  Salaries $17,462.91 

General  Office  Expenses  and  Supplies 918.45 

Telephones  and  Telegrams i53-i6 

Legal  Expense 172.82 

Traveling  Expense  of  Administrative  Officers  900.00 

Postage  Expense 2,135.54 

Stationery  and  Printing — Office 530.79 

Heat  and  Light— Office 918.19 

Miscellaneous 2,012.92 

$25,204.78 

General :  

Repairs  and  Maintenance  of  Buildings $5,852.39 

Experimental   Expense — Processes  and   New 

Goods 2,888.49 

Experimental  Expense — Machinery 1,288.44 

$10,029.32 

Total  Administrative  and  General  Expense 35,234.10 


Profit  from  Operations $115,527-37 

Additions  to  Income: 

Interest  on  Notes  Receivable $2.71 

Sundry  Sales  of  Materials  and  Empty  Con- 
tainers          1,480.57 

Discounts    Gained  on    Creditors'    Accounts 

(Cash  Discounts) 4,700.00 

Interest  on  Bank  Balances 1 12.10 

Total  Additions  to  Income. 6,295.38 

Total $121,822.75 

Deductions  from  Income: 

Taxes,  Licenses,  and  Fees $2,627.86 

Fire   Protection 2,704.99 

Discounts    Lost    on     Customers'     Accounts 

(Cash  Discounts) 3,788.15 

Interest  and  Discounts — Notes  Payable 22,131.77 

Collection  Fees  and  Other  Bank  Charges 7i-05 

Total  Deductions  from  Income 31,323.82 

Gross  ProHt  and  Income  from  Operating  and  Other  Sources      $90498.93 


STATEMENT    OF    INCOME  407 

Statement  of  Income — Continued 
Extraordinary  Losses  of  the  Period: 

Frozen  Goods $842.84 

Accounts  Receivable — Uncollectable 2,635.55 

Breakage  of  Carboys  and  Other  Empty  Con- 
tainers Returnable  to  Shippers 254.77 

Total  Extraordinary  Losses  of  the  Period 3,733- 16 

Net  Profit  for  the  Year  Ended  December  31,  igjs $86,765.77 

Reserved: 

For  Depreciation  of  Physical  Assets $9,481.39 

For  Possible  Losses  of  Accounts  Receivable. .        2,715.34 

Total  Reserved 12,196.73 

ProUt  and  Loss  Surplus  at  December  31,  191 3 $74,569.04 

Surplus  at  January  i,  1913 $171,368.31 

Less  Adjustments  during  the  Period: 
Returned  Sales  of  prior  periods,  and  Frozen 
Goods  sold  in  prior  periods,  the  profit  on 
which  figures  in  the  surplus  as  established 
at  January  i,  1913,  including  freight  and 
all  expenses  paid  by  the  Company  on  such 
returns 8,652.33 

Net  Adjusted  Surplus,  January  i,  1913 162,715.98 

Surplus  at  January  i,  1914  (as  per  Balance  Sheet  of  this 

Company  given  in  the  foregoing) $237,285.02 


Comment  on  the  Statement 

If  the  internal  anatomy  of  the  statement  varies  at  all,  the 
variations  are  due,  not  to  elasticity  of  the  mechanism,  but 
to  differences  of  opinion  as  to  the  legitimacy  of  theories 
which  establish  the  position  to  be  occupied  by  individual 
facts. 

Some  accountants  claim  that  the  income  from  sales  is 
represented  by  the  total  of  the  charges  to  customers,  less : 

i-a.  The  credits  taken  by  them  for  returns,  canceling 
the  sales  in  part  or  in  full 


438 


FINANCIAL    STATEMENTS 


b.  Allowances  given  to  them  for  shortages,  injuries 

to  goods,  etc. 

c.  Trade  discounts 

2.  All  expenses  which  the  vendor  had  agreed  to  stand 
in  order  to  consummate  the  sale,   such  as  the 
freight,  cartage,  and  other  possible  delivery  ex- 
penses to  the  point  where  the  goods  are  to  be 
delivered. 
Other  accountants,  on  the  other  hand,  while  admitting 
items  a,  b,  and  c  under  i,  deny  that  under  any  conditions 
freight  and  cartage,  expressage,  and  delivery  outward  are 
anything  but  selling  expense,  or,  in  some  cases,  administra- 
tive expenses. 

Cash  Discounts 

Economically  speaking,  cash  discounts  given  and  re- 
ceived measure  the  ability  of  the  administration  to  give  up 
part  of  the  income  from  sales,  in  order  that  it  may  obtain  a 
greater  benefit  in  the  settlement  of  its  accounts  payable.  In 
other  words,  cash  discounts  given  are  considered  as  a 
financial  bait  intended  to  induce  cash  to  flow  in  more  readily 
than  the  terms  of  credit  give  the  right  to  expect,  in  order 
that  this  cash  may  be  used  to  take  advantage  of  similar  offers 
by  creditors.  It  is  said,  however,  that  unless  rates  of  dis- 
counts are  obtained  in  a  greater  amount  than  they  are  given, 
discounts  on  both  sides  are  useless.  Many  accountants,  of 
course,  refuse  to  consider  cash  discounts  otherwise  than 
as  deductions  from  income  from  sales  or  from  cost  of  goods. 

Cost  of  Goods 

The  section  of  the  statement  which  contains  the  cost  of 
the  goods  sold  is  the  one  which  gives  rise  to  the  widest 
differences  of  opinion.  Speaking  of  the  cost  of  manu- 
factured goods,  some  accountants  claim  that  it  is  represented 
by: 


STATEMENT    OF    INCOME  439 

1.  Pre-process  cost,  i.e.,  freight  inward,  handling  and 

store  charges 

2.  Material  consumed 

3.  Labor  expended 

4.  Manufacturing  overhead  applicable  on  some  legiti- 

mate basis,  and  including,  among  other  items,  re- 
pairs to  machinery  and  tools  and  depreciation 
thereof 

5.  General  factory  overhead  applicable  as  above  and 

including  rent,  actual  or  theoretical,  of  factory 
space,  interest  on  capital  invested  in  the  factory, 
taxes  on  factory  building,  fire  protection  of  the 
manufacturing  property,  etc. 
An  equally  positive  group  of  accountants  deny  that  de- 
preciation, being  at  best  an  estimate,  can  be  charged  to  cost 
of  goods  which,  supposed  to  be  accurately  positive,  cannot 
afford  to  deal  with  estimates.    They  claim,  further,  that  in- 
terest on  the  investment  in  physical  assets  necessary  to  the 
proper  conduct  of  the  business,  is  cost  to  the  buyer  of  the 
goods,  and  is,  as  such,  properly  included  in  the  sale  price 
of  the  goods  offered  for  sale,  but  is  not  cost  of  manufacture. 

Interest  as  an  Element  of  Cost 

Among  all  these  theories,  the  business  man  often  loses 
his  way ;  he  reads  a  book  on  cost-finding  advocating  the  in- 
clusion of  interest  and  theoretical  rent  among  the  com- 
ponents of  the  cost  of  goods,  and  he  adopts  the  theory,  until 
it  is  pointed  out  to  him  that  theoretical  rent  and  theoretical 
interest,  when  added  to  cost,  must  be  taken  as  income ;  that 
if  the  closing  inventory  is  large,  it  is  inflated  by  theoretical 
values  which,  reflected  in  the  income,  make  him  subject 
to  a  revenue  tax  greater  by  a  certain  percentage  of  the 
theoretical  values  than  the  amount  which  he  would  other- 
wise pay.  Then,  realizing  that  he  has  actually  received 
neither  rent  nor  interest,  he  is  not  quite  so  sure  of  the 


440  FINANCIAL    STATEMENTS 

infallibility  of  his  author's  views.  If  proper  appreciation  of 
one's  welfare  is  able  to  settle  the  odious  controversies  into 
which  accountants  have  been  dragged  concerning  interest 
applicable  to  cost,  the  Federal  Government  should  be 
thanked  for  taxing  income. 

Book  Increase  of  Cost 

It  is  undeniable  that  when  the  creation  of  a  new  depart- 
ment is  contemplated  by  a  business  enterprise,  and  it  is  de- 
sired to  compute  the  probable  cost  of  the  new  departure,  it 
is  proper  to  include  in  the  statistical  computations  every  item 
which  may  represent  a  possible  channel  of  outgo  for  capital ; 
but  much  of  the  data  thus  marshaled  is  only  statistical, 
and  has  no  value  as  financial  fact,  when  weighed  upon  the 
scales  of  actuality.  We  have  all  heard  the  argument  to  the 
effect  that  when  a  man  goes  into  business  he  expects  to 
secure  a  capital  return  at  a  rate  which,  after  deduction 
therefrom  of  what  his  capital  would  produce  if  invested  in 
securities,  will  appear  fair  to  him.  According  to  this,  if  an 
individual,  by  investing  his  wealth  in  a  business  enterprise, 
makes  io%  on  his  investment,  he  has  the  right  to  say:  "I 
could  make  6%  by  investing  in  bonds  and  mortgages;  the 
difference  is  not  worth  my  while."  With  such  an  argument 
to  defend  his  idleness  a  man  would  command  little  respect ; 
and  yet,  by  charging  cost  of  goods  with  interest  lost  by 
investing  wealth  in  capital  assets,  we  end  by  reducing  the 
gross  profits  on  sales  to  a  percentum  which  may  lead  to  a 
disastrous  conclusion.  But  the  worst  of  it  all  is  that,  con- 
trary to  the  principle  of  business  which  states  that  with  the 
efflux  of  years,  carrying  experience  in  its  wake,  the  cost  of 
manufacturing  should  steadily  become  smaller,  the  inclu- 
sion of  theoretical  interest  in  cost  makes  such  cost  climb 
upwards  in  direct  ratio  with  the  increase  of  physical  assets. 
Thus,  the  more  profits  we  reinvest  in  the  business  in  a 
physical  way,  the  more  it  costs  us  to  manufacture. 


STATEMENT    OF    INCOME 


441 


In  the  example  of  the  statement  of  income  submitted 
above,  taxes  and  fire  protection  have  been  treated  as  deduc- 
tions from  income.  This  is  in  accordance  with  the  tenets  of 
the  economic  theory  of  income,  which  state  that  everything 
which  one  pays  out  for  the  protection  of  the  capital  repre- 
sented by  physical  assets,  is  equivalent  to  voluntary  sharing 
of  one's  income  with  some  one  else  willing  to  give  his  serv- 
ices in  return  for  proper  compensation. 

Statement  in  Account  Form 

The  statement  of  income  presented  on  pages  433-437 
could  be  prepared  in  account  form  instead  of  in  report  form 
without  losing  any  of  its  value,  lucidity,  or  analytical  power. 
The  truth  of  this  assertion  will  be  demonstrated  by  the 
following  skeleton : 


The  Black  Diamond  Manufacturing  Company 

Profit  and  Loss  Account 

For  the  Year  Ended  December  31,  1913 


Cost  of  Goods  Sold $. 

Gross  Profit  on  Sales 

$• 

Selling  Expense $. 

Selling  Profits 

$. 

General  and  Administra- 
tive Expense $. 

Profit  from  Operations . .   . , 


Income  from  Sales: 

Sales $. 

Less  Deductions 

Net  Sales $. 

Gross    Profit    on    Sales 
(brought  down) $. 

$. 

Selling  Profits   (brought 
down)  $. 


442 


FINANCIAL    STATEMENTS 


The  Black  Diamond  Manufacturing  Company 

Profit  and  Loss  Account 

For  the  Year  Ended  December  31,  1913 — Continued 


Deductions  from  Income  $, 
Gross  Profit  and  Income 
from  operating  and 
other  sources 

$. 

Profit  and  Loss  Debits..  $. 
Net  Profit  for  the  Period  . . 

$. 
1= 
Appropriations    for    Re- 
serves    $. 

Profit  and  Loss  Surplus 
for  the  Period 

$. 


Profit    from    Operations 

(brought  down) $. 

Additions  to  Income 

$. 

Gross  Profit  and  Income 
from  operating  and 
other  sources  (brought 
down)  $. 

Profit  and  Loss  Credits. .   . . 

$. 

Net  Profit  for  the  Period 
(brought  down) $. 

$. 


Surplus 


1913 

Dec.  31  Adjustments $. 

Balance 


1913 

Jan,     I  Balance $. 

Dec.  31  Adjustments 

"     "  Profit  and  Loss.   .. 

$. 


Statement  for  Steam  Roads  Engaged  in  Interstate  Traffic 
This  statement  is  divided  into  two  distinct  sections,  one 

for  income  and  one  for  profit  and  loss. 

The  income  section  has  a  skeleton  of  which  the  following 

are  the  most  important  parts : 


STATEMENT    OF    INCOME  ^^ 

1.  Railway  Operating  Income % 

2.  Other  Income 

1  plus  2  =  Gross  Income  (or  Loss) $ 

3.  Deductions  from  Gross  Income 

Remainder  is  Net  Income  (or  Loss) $ 

4.  Disposition  of  Net  Income 

Remainder,  transferred  to  debit  or  credit  of  Profit  and 
Loss $ 


The  skeleton  of  the  profit  and  loss  section  is  as  follows 

Credits: 

Balance  at  beginning  of  fiscal  period $ 

1.  Credit  Balance  transferred  from  Income  Account 

2.  Profit  on  Road  and  Equipment  Sold 

3.  Delayed  Income  Credits 

4.  Miscellaneous  Credits 

Balance  carried  to  General  Balance  Sheet 

$ 


Debits: 

Balance  at  beginning  of  fiscal  period $. 

5.  Debit  Balance  transferred  from  Income  Account 

6.  Appropriations  of  Surplus  to  Sinking  and  Other  Reserve 

Funds  

7.  Dividend  Appropriations  of  Surplus 

8.  Appropriations  of  Surplus  for  additions  and  betterments. .   . . 

9.  Appropriations  of  Surplus  for  new  lines  and  extensions  . . 

10.  Stock  Discount  extinguished  through  Surplus .. 

11.  Debt  Discount  extingniished  through  Surplus 

12.  Miscellaneous  Appropriations  of  Surplus 

13.  Loss  on  Retired  Road  and  Equipment 

14.  Delayed  Income  Debits 

15.  Miscellaneous  Debits 


Balance  carried  to  General  Balance  Sheet $. 


So  far  as  the  income  statement  is  concerned,  the  first 
section  is  of  great  interest  because  it  opposes : 

I.  Rail  operating-  revenues  to  rail  operating  expenses. 


444  FINANCIAL    STATEMENTS 

2.  Auxiliary  operating  revenues  to  auxiliary  operating 
expenses,  and  adds  the  net  result  of  the  latter 
group  of  opposing  items  to  the  net  result  of  the 
former  group. 

Under  the  heading  "Disposition  of  Net  Income,"  there 
are  given : 

1.  Appropriations  of  income  for  sinking  and  other  re- 

demption funds 

2.  Dividend  appropriations  of  income 

3.  Appropriations  of  income  for  additions  and  better- 

ments 

4.  Appropriations  of  income  for  new  lines  and  exten- 

sions 

5.  Stock  discount  extinguished  through  income 

6.  Miscellaneous  appropriations  of  income 

It  will  be  noted  with  interest  that  the  requirements  of 
the  Interstate  Commerce  Commission  demand  a  strict  dif- 
ferentiation between  income  and  surplus.  It  is  to  be  hoped 
that  American  accountants,  when  presenting  statements  sup- 
posed to  be  analytical  and  enlightening,  will  have  for  the 
meanings  of  accounting  facts,  the  respect  which  they  de- 
serve. It  is  well  enough  for  the  majority  of  us  to  treat  all 
transactions  of  a  period  which  have  resulted  in  a  gain,  a 
loss,  a  revenue  expenditure,  or  an  appropriation  of  profits, 
as  debits  or  credits  to  the  Profit  and  Loss  account.  It  is 
also  quite  satisfactory  to  many  that  capital  expenditures  be 
recorded  on  the  credit  side  of  the  account  which  produced 
the  funds.  But  our  statements  too  often  fail  to  show  that 
some  losses  and  gains  affect  past  profits  undistributed ;  that 
some  expenditures  have  been  made  out  of  current  profits 
reinvested ;  that  dividends  have  been  declared  out  of  current 
profits ;  that  reserves  of  the  past  have  been  consumed  during 
the  current  period.  We  are  far  too  prone  to  treat  a  state- 
ment of  results  as  an  accumulation  of  figures  which  must 


STATEMENT    OF    INCOME 


445 


balance  "by  hook  or  by  crook"  and  are  too  willing  to  in- 
trench ourselves  behind  our  supposed  mastery  of  a  science 
the  very  elements  of  which  we  do  not  always  know. 

Statement  of  Cash  Receipts  and  Disbursements 

Many  accountants  believe  that  this  statement  is  merely 
a  recital,  more  or  less  logical,  of  the  cash  transactions  of  the 
period;  and  still  a  greater  number  believe  that  it  is  a  use- 
less duplication  of  figures  given  in  full  detail  by  the  cash 
book.  And  yet,  it  is  more  than  true  that  the  cash  book 
carries  forward  no  individual  amount  of  prior  transactions ; 
that  few  cash  books  can  be  provided  with  enough  columns 
to  give  a  clear  idea  of  the  transactions  which  they  record, 
and  that  a  clear  and  purposeful  resume  of  the  all-important 
cash  transactions  of  a  given  period  may  be  as  interesting 
to  the  officers  of  a  concern  as  the  other  financial  statements 
presented.  To  illustrate  this  point  the  statement  of  cash 
receipts  and  cash  disbursements  of  the  Black  Diamond 
Manufacturing  Company,  for  the  six  months  ended  Decem- 
ber 31,  19 1 3,  is  given  below : 

Black  Diamond  Manufacturing  Company 
Statement  of  Cash  Receipts  and  Disbursements 

Debits — Cash  Received: 

1.  From  the  Collection  of  Current  Assets : 

Customers'  Accounts $366,487.14 

Claims  against  Transportation  Companies        2,183.93 
Notes  and  Loans  Receivable,  and  Interest 
thereon 1,427-49    $370,098.56 

2.  From  the  Sale  of  Working  Assets : 

Materials  and  Supplies  Sold  to  Employees  $S9.oi 

Carboys  and  Empty  Containers 1,000.00         1,059.01 

3.  From  the  Incurrence  of  Liabilities: 

Notes  and  Loans  Payable $153,016.34 

Deposits  by  Employees 15.00 

Credit  Accounts  of  Officers 2,106. 10     155,13744 


446 


FINANCIAL    STATEMENTS 


Cash  Receipts  and  Disbursements— Cowh'nM^rf 


4.  From  Miscellaneous  Sources: 

Fire  Insurance  Premiums  Refunded $10.05 

Dividends  on  Mutual  Fire  Policies 364,38 

Refunds  by  Creditors,  for  overpayments 
and  allowances  not  deductible  from  bills  6.15  380.58 

5.  Total  Receipts  for  Period 526,675.59 

6.  Balance  on  Hand,  July  i,  1913 7,643.05 

7.  Total  Debits $534,318.64 

Credits — Cash  Disbursed: 

1.  For  Liabilities  Liquidated : 

To  Creditors $171,350.29 

"    Employees — for  Wages 42,650. 19 

"    Banks  for  Loans  and  Notes 177.589.99 

"    Mortgagee — for  Reduction  of  Mortgage    19,000.00    $410,590.47 

2.  To  Interest  on  Indebtedness 6,251.07 

3.  For  Reduction  of  Credit  Accounts  of  Officers 9,680.15 

4.  For  Pre- Process  Cost  of  Goods  Manufactured: 

Freight  and  Cartage  Inward  and  Handling  Charge. ..  3,882.44 

5.  For  Factory  Overhead  Expenses : 

Automobile  Expense $317.80 

Warehouse  Cliarges  and  Cartage 40.25 

General  Expense  of  Factory 150.05 

Miscellaneous  Shipping  Expense 1,040.65          1.548.75 

6.  For  Selling  Expenses : 

Salaries  and  Commissions  of  Salesmen...     $58,115.40 

Advertising  Expense 10,251.53 

Special  Commissions  to  Jobbers 222.66       68,589.59 

7.  For  General  and  Administration  Expense: 

Salaries $12,000.00 

Postage  Expense 1,398.89 

Telephone   and   Telegrams. 93^06 

Traveling  Expense  of  Officers 450.06 

Legal  Expense 1,027.59 

Miscellaneous  Expense 33-42        15,003.02 

8.  Total  Cash  Disbursements  for  Period 515,545-49 

9.  Balance  on  Hand,  December  31,  1913 18,773.15 

10.  Total  Credits $534,318.64 


CHAPTER  XXXVIII 

THE  CONSOLIDATED  BALANCE  SHEET 

"Consolidation"  and  "Consolidated"  Balance  Sheets 

When  it  is  desired  to  gather  together  the  assets  and 
the  liabilities  of  several  companies  which  it  is  proposed  to 
consolidate,  the  resulting  balance  sheet  is  called  a  "Con- 
solidation of  the  Balance  Sheets  of  Companies  A,  B,  C," 
etc.,  at  a  given  date.  The  process  is  very  simple,  consist- 
ing merely  in  expressing  in  one  amount  the  assets  and 
the  liabilities  of  the  various  units.  Thus,  if  Companies 
A,  B,  and  C  have  a  capital  stock  of  $1,000,000  each,  the 
capital  stock  of  the  three  companies  together  is  given  as 
$3,000,000.    The  object  of  such  a  balance  sheet  is  to  show: 

1.  The  assets  which  will  enter  the  combination. 

2.  The  liabilities  to  be  liquidated  out  of  them. 

3.  The  total  equity  of  the  stockholders  taken  as  a 

whole,  in  order  that  the  probable  amount  of  the 
new  capital  stock  to  be  issued  if  the  consolida- 
tion takes  place,  may  be  estimated. 

In  contradistinction,  the  term  "consolidated"  is  made 
to  apply  to  balance  sheets  which  attempt  to  show  to  the 
owners  of  the  stock  of  a  company  holding  the  stock  of 
others,  the  exact  status  of  the  assets  which  they  control, 
and  of  the  liabilities  to  be  met  out  of  the  assets. 

The  purpose  of  holding  companies  is  to  acquire  the 
control  of  the  stock  of  operating  companies  and  to  receive 
as  their  income  the  income  of  these  companies.     It  is 

447 


448 


FINANCIAL    STATEMENTS 


plain,  of  course,  that  behind  the  financing  scheme  there 
lies  an  internal  organization  created  with  the  object  of 
reducing,  through  systematic  and  enlightened  manage- 
ment, the  cost  of  operating  the  controlled  companies.  It 
is  also  evident  that,  in  principle,  the  financing  of  a  weak 
member  of  the  community  of  components,  can  be  attended 
to  much  more  economically  through  internal  channels 
than  it  can  by  means  of  outside  assistance.  Thus,  it  is  not 
infrequent  to  find  on  the  balance  sheet  of  a  controlled 
company  an  asset  which  is  the  liability  of  another  con- 
trolled company.  The  situation  created  by  such  internal 
financing,  while  not  in  the  least  peculiar,  is  interesting 
because  it  raises  the  question  of  accounting  by  offsets. 

If  a  father  had  intrusted  the  management  of  $300,000 
of  personal  property  to  three  of  his  sons,  in  equal  amount, 
they  to  enjoy  the  income  of  the  trust,  it  might  be  that, 
at  the  end  of  a  given  period,  the  marshaling  of  the  units 
of  the  principal  of  the  trust  fund  might  show  that  John 
had  loaned  $50,000  to  James,  who  in  turn  had  loaned 
$25,000  to  Charles.  But  the  balance  sheets  submitted  by 
the  three  trustees  would  not  in  the  aggregate  reveal  any- 
thing of  great  importance  to  the  father,  since  the  fund 
remains  intact.  If  James  repaid  John  the  $50,000  which 
he  owes  him,  and,  in  turn,  Charles  repaid  to  James  the 
$25,000  loaned  by  the  latter,  John's  balance  sheet  would 
be  richer  in  liquid  assets,  while  that  of  James  and  Charles 
would  be  poorer  in  liquid  assets  and  richer  in  reduction 
of  liabihties;  but  the  father  would  not  have  one  cent  more. 

If,  then,  the  components  of  a  holding  company,  as 
represented  by  the  stock  which  the  latter  controls,  have 
been  financed  one  by  the  other,  all  the  debts  of  an  indi- 
vidual member  which  are  the  assets  of  another  member 
must  be  omitted  from  a  statement  endeavoring  to  show 
the  exact  status  of  the  assets  controlled  by  the  parent 
company. 


THE    CONSOLIDATED    BALANCE    SHEET  449 

Form  of  Consolidated  Balance  Sheet 

The  following  problem  taken  from  the  New  York 
C.P.A.  examination  of  January,  191 3,  is  brought  in  as  a 
basis  for  the  preparation  of  a  consolidated  balance  sheet; 

Company  C  was  incorporated  in  May,  1910,  to  acquire 
the  stock  of  Companies  A  and  B.  Company  C's  capital 
stock  is  divided  into  preferred,  $2,500,000,  common, 
$1,500,000;  all  the  stock  is  outstanding  and  fully  paid; 
it  has  been  issued  (i)  for  stock  to  the  stockholders  of 
Companies  A  and  B,  (2)  $20,000  of  preferred  for  organiza- 
tion expenses,  (3)  for  cash.  The  stockholders  of  A  and  B 
received  preferred  stock  for  the  intrinsic,  undepreciated 
book  value  of  the  assets,  as  reflected  by  the  following 
balance  sheets  of  their  companies  at  June  30,  1910,  and 
$300,000  of  common  stock  divisible  equally  between  Com- 
panies A  and  B. 

Assets 

Plant  Land $90,000  $195,000 

Building  and  Equipment 254,000  318,000 

Machinery  and  Tools 228,600  276,800 

Transportation  Equipment 21,000  17,000 

Investment  in  Land 150,000 

Investment  in  Bonds — Co.  B 60,000         

Investment— Stocks 200,000         

Goods  in  Process 45,ooo  49,341 

Finished  Goods : 69,000  76,340 

Material  and  Supplies 58,000  51,300 

Cash 17,420  19,175 

Accounts  Receivable 51,000  92,800 

Demand  Notes— Co.  B 5,ooo         

Accrued  Interest 1,800        

$1,100,820    $1,245,756 


Liabilities 

Capital  Stock  Outstanding: 

Common  $700,000    $1,000,000 

Preferred 100,000        

6%  Bonds,  191 5,  J.  &  J.  and  Interest  Accrued 92,70* 


59,8oo 

41,656 

65,800 

35,000 

18,320 

13,400 

5,000 

24,900 

30,000 

5,000 

2,000 

16,000 

111,000 

26,000 

$1,100,820 

$1,245,756 

4^0  FINANCIAL    STATEMENTS 

Liabilities — Continued 

Accounts  Payable 

Loans  Payable 

Audited  Vouchers  Unpaid 

Demand  Notes  Payable 

Reserve  for  Depreciation 

Reserve  for  Doubtful  Accounts 

Reserve  for  Contingencies 

Surplus   ■• 


Between  July  i  and  July  31,  1910,  the  following 
transactions  occurred:  organization  expenses  paid  in  cash 
by  Company  C,  $5,000;  intercompany  advances  by  C:  to 
A,  $60,000;  to  B,  $60,000;  Company  A  reduced  its  ac- 
counts payable  by  $25,000;  its  loans  payable  by  $30,000 
and  its  audited  vouchers  by  $15,000;  Company  B  reduced 
its  accounts  payable  by  $29,500,  liquidated  its  audited 
vouchers  unpaid  and  its  interest  due  under  the  bonds. 

The  manufacturing  operations  of  the  period  show: 
Company  A — labor,  $10,000;  overhead  expenses,  $8,000; 
materials  consumed,  $9,886;  inventory  of  goods  in  process, 
$46,300;  of  finished  goods,  $50,740;  selling  expenses  paid, 
$1,600;  administration  expenses,  $2,500;  sales,  $72,500; 
collections  of  open  accounts,  $86,400.  Company  B — 
labor,  $3,600;  overhead,  $2,350;  materials,  $5,210;  inven- 
tory of  goods  in  process,  $40,500;  of  finished  goods, 
$46,380;  sales,  $98,000;  collections,  $109,150;  administra- 
tion expenses,  $3,000.75  ;  selling  expenses,  $1,040. 

No  materials  were  purchased  during  the  period  and 
the  current  expenses  were  paid  as  soon  as  the  invoices 
were  audited.  Company  A  declared  a  dividend  of  $100,000 
and  Company  B  a  dividend  of  $25,000, 

Prepare  the  consolidated  balance  sheet  of  Companies 
A  and  B  and  C,  at  July  31,  1910,  to  be  submitted  to  the 
directors  of  Company  C  and  so  arranged  as  to  show  them 
the  exact  detail  of  the  properties  that  they  control. 


THE  CONSOLIDATED  BALANCE  SHEET 


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THE  CONSOLIDATED  BALANCE  SHEET 


453 


Formation  of  Consolidated  Balance  Sheet 

A  discussion  of  the  foregoing  solution  will  be  suflRcient 
to  clear  up  the  supposed  intricacies  of  the  consoHdated 
balance  sheet.  Before  proceeding,  however,  it  may  be 
well  to  present  the  ledger  accounts  of  the  three  companies, 
built  up  from  the  facts  given  by  the  text  of  the  problem. 
These  are  given  in  order  to  show  how  the  closing  facts  are 
obtained. 

Ledger  Accounts 

Company  A 

Cash 


Balance $17,420.00 

Company  C 60,000.00 

Accounts  Receivable...     86400.00 
Interest  on  Bonds 1,800.00 


$165,620.00 


Balance $73,520.00 


Accounts  Payable $25,000.00 

Loans  Payable 30,000.00 

Audited  Vouchers 15,000.00 

Labor  10,000.00 

Factory  Expense 8,000.00 

Selling  1,600.00 

Administration  Expense  2,500.00 

Balance 73,520.00 


$165,620.00 


Goods  in  Process 


Balance $45,000.00 

Materials  and  Supplies..      9,886.00 

Cash — Labor 10,000.00 

Cash — Factory  Expense     8,000.00 


$72,886.00 


Balance  $46,300.00 


Finished  Goods $26,586.00 

Inventory 46,300.00 


$72,886.00 


454 


FINANCIAL    STATEMENTS 
Profit  and  Loss 


Finished  Goods $44,846.00 

Selling  Expense 1,600.00 

Administration  Expense      2,500.00 
Surplus  23,854.00 


$72,800.00 


Sales 

Interest  on  Bonds. 


$72,500.00 
300.00 


$72,800.00 


Finished  Goods 


Goods  in  Process $26,586.00 

Balance   69,000.00 


$95,586.00 


Inventory 

Profit  and  Loss. 


$50,740.00 
44,846.00 

$95,586.00 


Surplus 


Dividends   $100,000.00 

Balance   34,854.00 


$134,854.00 


Balance    $111,000.00 

Profit  and  Loss 23,854.00 


$134,854.00 


Balance   $34,854.00 

Company  B 
Cash 


Balance   $19,175.00 

Company  C 60,000.00 

Accounts  Receivable. ...  109,150.00 


$188,325.00 


Balance $132,734.25 


Accounts  Payable 

Audited  Vouchers 

Interest  on  Bonds 

Labor  

Factory  Expense 

Selling  

Administration  Ex- 
penses   

Balance  


$29,500.00 
13,400.00 
2,700.00 
3,600.00 
2,350.00 
1,040.00 

.      3,000.75 
.  132,734.25 

$188,325.00 


THE    CONSOLIDATED    BALANCE    SHEET 
Goods  in  Process 


455 


Balance $49,341.00 

Materials  and  Supplies.      5,210.00 

Cash — Labor 3,600.00 

Cash — Factory  Expense      2,350.00 


$60,501.00 


Balance $40,500.00 


Finished  Goods $20,001.00 

Inventory 40,500.00 


$60,501.00 


Profit  and  Loss 


Finished  Goods $49,961.00 

Selling  Expense 1,040.00 

Administration  Expense      3,000.75 

Interest  on  Bonds 450.00 

Surplus 43,548.25 


$98,000.00 


Sales $98,000.00 


$98,000.00 


Finished  Goods 


Goods  in  Process. 
Balance 


$20,00 1. Ov/ 

76,340.00 
$96,341.00 


Inventory 

Profit  and  Loss. 


$46,380.00" 
49,961.00 

$96,341.00 


Surplus 


Dividends 
Balance  .. . 


$25,000.00 
44,54825 

$69,548.25 


Balance 

Profit  and  Loss. 


$26,000.00 
43,548.75 

$69,548.25 


456 


FINANCIAL    STATEMENTS 

Company  C 
Cash 


Preferred     Capital 

Stock $465,100.00 

Common  Capital  Stock  1,200,000.00 


$1,665,100.00 


Balance $1,540,100.00 


Advances  $120,000.00 

Organization  Expenses        5,000.00 
Balance 1,540,100.00 


$1,665,100.00 


Capital  Stock — Preferred 


Preferred     Capital 
Stock  Authorized.  .$2,500,000.00 


$2,500,000.00 


Investment  in  Stocks.  $956,900.00 
Investment  in  Stocks.  1,058,000.00 
Organization  Expenses  20,000.00 
Cash 465,100.00 


$2,500,000.00 


Capital  Stock — Common 


Common  Capital  Stock 

•    Authorized $1,500,000.00 


$1,500,000.00 


Investment  in  Stocks.    $300,000.00 
Cash 1,200,000.00 


$1,500,000.00 


Investments  in  Stocks  of  Other  Companies 


Preferred     Capital 

Stock $956,900.00 

Preferred    Capital 

Stock 1,058,000.00 

Common  Capital  Stock     300,000.00 


$2,314,900.00 


Balance  $2,314,900.00 


Balance $2,314,900.00 


$2,314,900.00 


THE  CONSOLIDATED  BALANCE  SHEET 


457 


The  points  of  interest  in  the  foregoing  problem  appear 
to  be : 

1.  The  amount  of  cash  which  has  been  obtained  by 
Company  C  through  the  issue  of  stock  is  not  given;  and 
since  the  amount  of  stock  issued  by  C  in  exchange  for  the 
capital  stock  of  A  and  B  is  not  mentioned,  the  accurate 
building  up  of  the  cash  account  of  C  depends  upon  the 
understanding  of  what  constitutes  "intrinsic,  undepre- 
ciated book  value  of  the  assets." 

2.  The  good-will  which,  so  far  as  C  is  concerned,  repre- 
sents the  difference  between  the  intrinsic  book  value  of 
the  assets  and  the  price  paid  for  the  stock  of  A  and  B,  i.e., 
$300,000,  will  have  to  be  expressed  in  the  consolidated 
balance  sheet  at  a  figure  which  can  be  obtained  only  from 
careful  consideration  of  its  components. 

3.  All  the  intercompany  holdings  will  have  to  be 
eliminated  from  the  consolidation,  upon  the  ground  that 
this  exclusion  will  not  in  any  way  alter  the  status  of  a 
single  one  of  the  assets  of  A  and  B  controlled  by  C.  If 
this  test  cannot  be  applied  to  a  proposed  eliminiation,  it 
should  not  be  made. 

I.  The  Amount  of  the  Issues  of  Stock  for  Cash.  The 
term  "intrinsic,  undepreciated  book  value"  means  all  the 
assets  of  A  and  B,  as  appearing  on  the  balance  sheets 
submitted,  less  their  liabilities  to  outsiders,  no  cognizance 
whatever  being  taken  of  the  reserves.  Thus,  since  the 
intrinsic,  undepreciated  book  value  of  the  assets  of  A  and 
B  is  in  the  aggregate  $2,014,900,  this  amount  of  preferred 
stock  was  issued  by  C  to  the  stockholders  of  A  and  B. 
Further,  if  $20,000  of  the  same  stock  was  issued  for  organ- 
ization expense,  the  company  must  have  received  $465,100 
in  cash  for  the  balance.  As  to  the  common  stock,  it  is 
plain  that  the  price  paid  in  stock  by  Company  C  for  the 
excess  of  cost  over  intrinsic  value  being  $300,000,  the 


458 


FINANCIAL    STATEMENTS 


balance  of  the  authorization,  i.e.,  $1,200,000,  was  issued 
for  cash. 

2.  The  Component  Parts  of  the  Good-Will. 

The  assets  of  A  and  B,  as  appearing  in  the  balance  sheets  of 
these  two  companies  at  June  30,  1910,  aggregate $2,346,576.00 

Deducting  from  this  figure  the  amount  which  has  been  ac- 
quired through  the  use  of  credit,  i.e.,  through  the  in- 
currence of  liabilities  to  outsiders 331,676.00 

We  obtain  an  amount  of $2,014,900.00 

Which  represents,  according  to  principles  of  accounting, ..     1,800,000.00 
of  assets  acquired  through  the  use  of  the  capital  con- 
tributions of  the  stockholders,  as  evidenced  by  the  capital 
stock  liabilities  of  the  two  companies. 

Deducting  the  capital  stock  we  have  a  remainder  of $214,900.00 


which  cannot  be  anything  else  than  the  assets  acquired  by 
companies  A  and  B  through  the  reinvestment  of  their 
undivided  profits  of  prior  periods,  as  measured  by : 

1.  The  surplus  available  for  dividends $137,000.00 

2.  The  surplus  appropriated  for  the  purpose  of  reserves..         77,900.00 

$214,900.00 


Thus  we  have  found  two  of  the  components  of  the 
good-will  acquired  by  Company  C.  As  to  the  third,  it 
must  of  necessity  be  the  $300,000  of  common  stock  issued 
by  C  in  excess  of  the  intrinsic  value  of  the  assets  of  A  and 
B.  To  prove  that  the  resulting  figure  of  $514,900,  which 
is  called  good-will  on  the  consolidated  balance  sheet  sub- 
mitted above,  is  truly  what  it  pretends  to  be,  let  us  assume 
that,  instead  of  expressing  its  investment  in  stocks  of 
other  companies  at  cost,  as  appears  to  have  been  done, 
Company  C  had  expressed  it  at  the  par  of  the  stocks 
acquired.  The  journal  entry,  under  these  circumstances, 
would  have  been : 


THE    CONSOLIDATED    BALANCE    SHEET  459 

Investment  in  Stocks  of  Other  Companies. . .  $1,800,000.00 

Good-Will 514,900.00 

To  Capital  Stock — Preferred $2,014,900.00 

Capital  Stock — Common 300,000.00 

For  acquisition  of  the  stock  of  companies 
A  and  B,  the  good-will  being  represented 
by: 

1.  Undivided  profits $137,000.00 

2.  Appropriations  of  surplus      77,900.00 

3.  The  good-will  value  of  the 

investment  covers  the 
intrinsic  value  of  the 
assets  acquired 300,000.00 

$514,900.00 


3.  The  Eliminations.  Irrespective  of  their  importance 
to  Companies  A  and  B  in  their  capacity  as  separate  enti- 
ties, the  debts  of  A  to  B  and  of  B  to  A  are  nothing  to  C, 
who  owns  the  stock  of  both.  It  is  plain  that  if,  for  instance, 
the  demand  notes  held  by  A  against  B  were  to  be  repaid 
by  the  latter,  A  would  have  more  cash,  and  less  claims 
against  other  companies,  while  B  would  have  less  cash, 
and  a  lesser  amount  of  liabilities  to  outsiders.  But  it  is 
also  evident  that  the  consolidation  of  the  cash  account 
of  A,  B,  and  C  would  give  a  figure  absolutely  identical 
with  the  one  shown  in  the  balance  sheet,  i.e.,  $1,746,354.25, 
which  is  the  true  extent  of  C's  control  of  available  cash. 
If  the  same  reasoning  is  applied  to  any  one  of  the  elimina- 
tions shown  in  the  above  solution,  the  same  result  will  be 
obtained. 

The  investment  in  stocks  of  other  companies  as  carried 
by  C  in  its  balance  sheet,  must  be  eliminated  because,  in- 
stead of  expressing  the  amount  of  the  investment,  it  is 
required  that  the  assets  which  it  controls,  subject  to 
whatever  liabilities  attach  to  them,  be  expressed  in  detail. 
The  elimination  of  the  capital  stock  of  Companies  A  and  B 


460 


FINANCIAL    STATEMENTS 


is  indicated  by  logic.  If  the  said  stock  originally  con- 
trolled the  assets  of  A  and  B,  and  has  since  been  replaced 
by  the  stock  of  C,  it  is  only  the  latter  which  controls  the 
assets;  the  former  is  a  nonentity  to  C  for  purposes  of  a 
consolidated  balance  sheet.  It  represents  only  docu- 
mentary evidence  of  the  transfer  of  the  assets  which  were 
originally  acquired  out  of  it. 


CHAPTER  XXXIX 

THE  STATEMENT  OF  AFFAIRS 

Appointment  of  Receivers 

The  term  "financial  embarrassment"  suggests  to 
many  people  the  state  of  insolvency  and  consequent  re- 
ceivership. And  yet  the  appointment  of  receivers  by 
courts  of  equity  is  looked  upon  as  an  extreme  measure, 
only  to  be  resorted  to  when  the  courts  are  convinced  that 
such  action  is  essential  to  secure  properties  from  waste 
pending  readjustment  of  finances  or  eventual  liquidation. 
As  a  matter  of  law,  no  receiver  is  appointed  unless  the 
referee  in  the  case  has  found: 

1.  That  the  plaintiff  has  some  right  or  lien  upon  the 

properties  at  issue. 

2.  That  in  principle  he  has  a  legal  right  to  consider 

the  property  as  a  fund  to  be  devoted  to  the 
satisfaction  of  his  claim,  or 

3.  That  the  respondent  has  fraudulently  entered  into 

possession  of  the  thing  in  litigation,  or 

4.  That  insolvency  is  so  evident  that  the  assets  are 

in  serious  danger  of  being  lost  through  sheer 
waste,  to  the  prejudice  of  the  creditors. 

Status  of  the  Statement  of  Affairs 

To  the  student  of  accountancy,  the  statement  of  affairs 
is  essentially  a  receiver's  statement.  As  a  matter  of  fact, 
neither  the  receiver  nor  the  assignee  is  permitted  by  New 
York  courts  to  file  such  a  statement. 

461 


462  FINANCIAL    STATEMENTS 

A  receiver  may,  upon  being  appointed,  ask  an  account- 
ant to  prepare  for  him  a  statement  showing  what  are  the 
assets  of  the  concern  whose  affairs  he  is  to  administer,  and 
to  what  classes  of  liabilities  they  are  subject;  he  may  fur- 
ther wish  to  know,  as  soon  as  possible,  the  probable 
amount  of  the  free  assets  of  which  he  will  dispose  for  the 
settlement  of  unsecured  claims.  But  what  is  more  prob- 
able, he  will  ask  for  a  list  of  all  the  assets  and  of  all  the 
liabilities  as  they  stand  on  the  books.  Then  he  will  have 
the  assets  appraised;  he  will  ask  through  the  courts  that 
all  creditors  prove  their  claims  and,  within  a  reasonable 
time,  he  will  file  the  lists.  Subsequently,  he  will  keep  such 
accounts  as  will  permit  him  to  show  what  he  collected  on 
the  said  assets,  and  what  he  paid  on  the  Uabilities,  as  filed. 

Thus,  so  far  as  the  receiver  is  concerned,  the  "state- 
ment of  affairs,"  which  has  assumed  such  importance  in 
C.P.A.  examinations,  is  essentially  theoretical.  If  it  has 
any  value  at  all,  it  is  in  other  directions. 

A  concern  whose  finances  have  been  badly  managed 
may,  while  actually  prosperous  if  judged  by  the  standard 
of  profits,  be  compelled  to  throw  itself  on  the  mercy  of 
its  creditors  for  extension  of  time,  or  for  further  credit. 
Before  granting  the  request,  the  creditors  may  ask  that  a 
clear  insight  be  given  them  as  to: 

1.  The  financial  status  of  the  concern  if  liquidation 

of  its  affairs  is  deemed  advisable. 

2.  The  causes  of  the  conditions  which  make  further 

credit  necessary. 

3.  The  marshaling  of  the  losses  so  as  to  show  which 

are  due  to  mismanagement  and  which  to  un- 
profitable trading  conditions,  and  what  losses 
will  be  incurred  by  a  forced  liquidation,  if  such 
a  drastic  action  is  contemplated. 
Thus  understood,  the  theoretical  statement  of  affairs 
assumes  proportions  which  make  it  a  valuable  document 


THE    STATEMENT    OF    AFFAIRS 


463 


in  the  hands  of  creditors,  be  they  laymen  or  financial 
institutions.  In  truth,  the  statement  has  no  power  other 
than  that  which  it  borrows  from  the  power  of  logic  and 
accounting  analysis  of  the  one  who  prepares  it  and  draws 
proper  conclusions  from  the  arrangement  of  its  otherwise 
meaningless  results  in  a  deficiency  account. 

Asset  Side  of  Statement 

The  theoretical  form  of  the  statement  of  affairs  is  shown 
on  pages  464,  465. 

In  the  form  as  given  the  division  of  the  space  for 
"Estimated  to  Realize"  into  two  columns,  is  to  facilitate 
the  deduction  of  liabilities  from  assets,  or  assets  from 
liabiUties,  as  explained  below,  and  as  illustrated  by  the 
solution  of  the  New  York  C.  P.  A.  problem  given  on  page 
469. 

The  theoretical  skeleton  of  the  account  is  as  follows : 

1.  State  the  assets  in  the  probable  order  of  their 
realization. 

2.  Deduct  from  the  appraised  value  of  pledged  assets, 
the  amount  of  the  liabilities  which  they  secure  in  full. 

3.  Deduct  the  appraised  value  of  assets  partially  se- 
curing liabilities,  from  the  liabilities  to  which  they  are 
pledged. 

4.  Total  the  remainder  of  the  appraised  value  of  the 
assets. 

Liability  Side  of  Statement 

I.  State  the  liabilities  at  the  value  at  which  they  stand 
on  the  books,  classifying  them  as  follows: 

a.  Unsecured  Claims 

b.  Fully  Secured  Claims 

c.  Partially  Secured  Claims 

d.  Preferred  Claims 


464 


FINANCIAL    STATEMENTS 


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THE    STATEMENT    OF    AFFAIRS 


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466  FINANCIAL    STATEMENTS 

2.  Deduct  the  fully  secured  claims  from  the  assets 
which  are  pledged  to  them. 

3.  Deduct  the  appraised  value  of  assets  partially  se- 
curing liabilities  from  the  liabilities  to  which  they  are 
pledged,  and  extend  the  remainder  as  unsecured. 

4.  Deduct  the  preferred  claims  from  the  remainder  of 
the  appraised  value  of  the  assets  as  shown  by  the  second 
column  of  the  space  headed  "Estimated  to  Realize." 

5.  Total  the  unsecured  claims  as  extended  in  the 
second  column  of  the  space  headed  "Expected  to  Rank." 

Bring  the  statement  to  a  close  by  establishing  either 
on  the  asset  side,  or  on  the  liability  side: 

1.  The  amount  by  which  the  liabilities  unsecured  ex- 

ceed   the    remainder    of    free    assets,    at    their 
appraised  value;  or 

2.  The  amount  by  which  the  remainder  of  free  assets 

exceeds  the  unsecured  liabilities. 

Preparation  of  Statement  of  Affairs 

The  solution  of  the  following  problem  taken  from  the 
New  York  C.P.A.  examination  of  January,  191 2,  will 
illustrate  further  the  theory  of  the  statement  of  affairs 
and  the  deficiency  account,  and  also  the  method  of  their 
preparation. 

Problem 

Under  pressure  of  financial  difificulties  the  General 
Contracting  Company  has  applied  to  its  creditors  for  ex- 
tension of  credit.  The  creditors'  committee  has  engaged 
accountants  to  examine  the  books,  and  appraisers  to 
appraise  the  physical  property  of  the  company.  The 
examiners  and  appraisers  are  given,  as  a  basis  for  their 
work,  the  following  balance  sheet,  prepared  by  the  com- 
pany's bookkeeper  June  30,  191 1: 


THE    STATEMENT    OF    AFFAIRS 


467 


Debits 

Plant  and  Equipment $150,000 

Horse,  Wagon  and  Har- 
ness      3,000 

Machinery  and  Tools...  110,000 

Shop  and  Hand  Tools..  17,000 

Materials  and  Supplies..  38,000 

Finished    Goods 5,675 

Uncompleted  Contracts, .  72,300 

Cash 48,800 

Accounts  Receivable 11,150 

Notes  Receivable 15,000 

Accrued    Interest   on 

Notes  Receivable 530 

Stationery  and  Printing..  1,220 

Unexpired  Insurance....  280 


$472,965 


Credits 

Capital  Stock  Authorized 
and  Outstanding $100,000 

Bond  and  Mortgage  Pay- 
able, 6%,  due  Jan.  i, 
1912   85,000 

Notes   Payable 35,ooo 

Audited  Vouchers  Un- 
paid      156,000 

Uncompleted  Contracts, 
Instalments 45,ooo 

Dividend  No.  6  Payable.        5,000 

Wages  Accrued 2,650 

Interest  Accrued  on  Bond 
and  Mortgage  Payable  425 

Interest  Accrued  on 
Notes  Payable 470 

Reserve    for    Plant    and 

Plant  Equipment 6,000 

Reserve  for  Machinery 
and  Machine  Tools 5,40o 

Reserve  for  Shop  and 
Hand  Tools 1,500 

Reserve  for  Horse, 
Wagon  and  Harness. .        1,450 

Reserve  for  Contract 
Contingencies   5,200 

Surplus 23,860 

$472,955 


In  due  time  the  accountants  render  a  report  which, 
among  other  things,  contains  the  following  remarks: 

"The  account  'Finished  Goods'  represents  the  inven- 
tory, at  cost,  of  certain  machines  built  under  contract 
during  the  six  months  of  the  present  accounting  period 
ended  June  30,  191 1,  which  the  other  contracting  parties 
decline  to  accept,  owing  to  flaws  and  violations  of  speci- 
fications. The  accounts  receivable  are  made  up  as  fol- 
lows: (a)  subject  to  bona  fide  and  admittedly  reasonable 
claims  by  customers,  for  unsatisfactory  goods  manufac- 


468 


FINANCIAL    STATEMENTS 


tured  under  contract  during  prior  period,  $3,600;  (b)  last 
instalment  due  this  company  under  contracts  of  the  prior 
period,  completed  and  delivered,  $7,550;  the  aggregate 
amount  of  these  instalments  is  due  August  i,  191 1,  but  is 
subject  to  certain  guarantees  which  have  subjected  the 
company  to  fines  of  $1,500  on  account  of  defective  work; 
these  fines  will  be  deducted  from  the  instalments  when 
due;  the  balance  of  the  amount  of  $7,550  will  be  collected 
in  due  time.  The  account  'Uncompleted  Contracts,  In- 
stalments,' represents  amounts  paid  by  customers  during 
June,  191 1,  on  certain  contracts  reaching  a  specific  stage 
of  development.  The  unexpired  insurance  premiums 
would,  if  the  policies  were  canceled,  produce  $160.  There 
exists  no  liability  for  discounted  notes.  The  notes  re- 
ceivable on  hand  are  indorsed  by  responsible  parties." 

The  appraisers  report  as  follows: 

"The  physical  assets  of  the  company,  as  appraised  by 
us,  would  produce  at  forced  sale:  plant  and  plant  equip- 
ment, $90,000;  machinery  and  tools,  $55,000;  shop  and 
hand  tools,  $5,000;  horse,  wagon  and  harness,  $1,000, 
The  uncompleted  contracts  would  require,  to  carry  them 
to  completion,  an  expenditure  of  the  following:  material, 
$10,000;  labor,  $7,000;  factory  overhead,  $3,000,  irrespec- 
tive of  general  overhead.  We  are  informed  by  the  surety 
company,  who  have  guaranteed  the  completion  of  the 
contracts,  that  it  will  undertake  to  complete  them  pro- 
vided this  company  will  sell  them  for  $9,000,  the  amount 
of  materials  which  we  have  estimated  to  be  necessary  for 
completion,  and  provided  further,  that  this  company  will 
accept  in  settlement  the  cost  to  it  of  the  contracts  as  they 
stand  on  its  books  at  June  30,  191 1,  with  4%  of  the  said 
amount  added  for  profits.  The  balance  of  the  materials 
and  supplies  would  produce  $20,000.  The  finished  goods 
are  worth  only  their  scrap  value,  i.e.,  $250.  The  station- 
ery and  printing  is  worth  $10." 


THE    STATEMENT    OF    AFFAIRS 


469 


The  books  of  the  company  show  that  the  contracts  in 
process  will,  when  completed,  produce  $130,000. 

From  the  above  facts  prepare: 

1.  Statement  of  affairs  at  June  30,  191 1. 

2.  Deficiency  account  that  will  account  logically  for 

the  losses  incurred  by  the  company  and  by 
its  creditors  under  the  assumption  that  the  cred- 
itors are  considering  favorably  the  dissolution 
of  the  company  and  the  completion  of  the  con- 
tracts by  the  guarantors. 


Solution 
Statement  of  Affairs 


Cash 

Accounts  Receivable : 

Good 

Uncollectable  

Notes  Receivable 

Accrued  Interest  on  Notes  Receiv- 
able   

Stationery  and  Printing 

Unexpired  Insurance  Premiums... 

Plant   and    Plant   Equipment    (re- 
serve for  depreciation  deducted) 

Less  Bond  and  Mortgage  Payable : 

Principal  $85,000.00 

Interest  42500 


Assets 

Book  Value      Estimated  to  Realize 
...    $48,800.00      $48,800.00 


6,050.00 

5,100.00 

15,000.00 

530.00 

1,220.00 

280.00 


Horse,  Wagon  and   Harness    (re- 
serve for  depreciation  deducted)  1,550.00 

Machinery  and  Tools 104,600.00 

Shop  and  Hand  Tools i  S.SOO.oo 

Materials  and  Supplies: 

To  be  sold  to  the  Surety  Company  10,000.00 

Balance  remaining  in  store 28,000.00 


144,000.00     $90,000.00 


6,050.00 
15,000.00 

530.00 

laoo 

160.00 


8542500         4,57500 


1,000.00 

55,000.00 

5,00a  00 

9,ooaoo 
ao,ooaoo 


470  FINANCIAL    STATEMENTS 

Statement  of  Affairs — Continued 

Book  Value  Estimated  to  Realize 

Finished  Goods $5,675-00  $250.00 

Uncompleted  Contracts 72,300.00  $75,192.00*     

Less   Instalments   collected   there- 
under   45,000.00       30,192.00 

Total $458,605.00  $i95>567-00 

Deduct  Preferred  Claims : 
Wages  Accrued 2,650.00 

Balance  available  for  distribution  to 
unsecured  creditors,  being  98.19% 
of  their  claims,  subject  to  ex- 
penses incident  to  realization  and 
liquidation $192,917.00 

Deficiency,  as  per  Account 3,55300 

Total $196470.00 


Unsecured  Claims: 
Notes  Payable: 

Principal  $35,000.00 

Interest 47aoo 

Audited  Vouchers  Unpaid 156,000.00 

Dividends  Payable 5,000.00 

Fully  Secured  Claims: 
Bond  and  Mortgage  Payable : 

Principal  $85,000.00 

Interest  425.00      85,425.00 


Liabilities 

As  Per  Books  Expected  to  Rank 


$35,000.00 

470.00 

156,000.00 

5,000.00 


Deducted  from  estimated  amount 

to  be  realized  on  property  pledged     $85425.00 

Partially  Secured  Claims    (None) 
Preferred  Claims: 

Wages  Accrued 2,650.00      

Deducted  from  remainder  of  free 

assets  estimated  to  be  realized 2,650.00 

*^Cost  +  4% 


THE    STATEMENT    OF    AFFAIRS 


471 


Statement  of  Affairs — Continued 


Uncompleted  Contracts:  As  Per  Books 

Received  in  Cash $45,000.00 

Instalments   received   in   cash,   de- 
ducted  from   the   amount   to   be 

realized  on  such  contracts 

Reserves,  Capital  and  Surplus: 

Reserves  for  Contract  Contingencies       5,200.00 

Capital  Stock 100,000.00 

Surplus 23,860.00 


Total  Book  Liabilities,  Capital  and 
Surplus $458,605.00 


Total  Deducted  from  Assets. 
Total  Unsecured  Claims 


Expected  to  Rank 


$45,000.00 


$133,075-00 


$196,470.00 


Preparation  of  Deficiency  Account 

From  the  foregoing  facts,  supported  by  the  analysis 
of  the  accounts  and  by  the  appraised  valuation  of  certain 
assets,  the  following  deficiency  account  is  established: 


Deficiency  Account 


Estimated  Losses: 

1.  On  Realization  of  Assets : 

Plant     and     Plant 

Equipment    $54,000.00 

Horse,     Wagon     and 

Harness    550.00 

Machinery    and    Ma- 
chine  Tools 49.600.00 

Shop  and  Hand  Tools     10,500.00 

Materials    and    Sup- 
plies        9,000.00 


Total $123,650.00 


Incident  to  Realization 

and  Liquidation  : 

Stationery  and  Print- 
ing       11,210.00 

Insurance  Premiums 
deferred  from 
prior  periods 120.00 


Total $1,330.00 


Net  Loss,  to  he  sustained  &y: 

1.  Unsecured  Creditors : 

Deficiency,     as     per 

statement   $3,553.00 

2.  Stockholders: 

Capital     Stock    Out- 
standing       100,000.00 

Surplus  : 

books. $23,860.00 
Add: 

Transfer  of  bal 
ance  of  Reserve 
for  Contract 
Contingencies.  .100.00     23,960.00 


472 


FINANCIAL    STATEMENTS 
Deficiency  Account — Continued 


Total  Losses  Due  to  or 
Incident  to  Realization 
and   Liquidation $124,980.00 


Operating  Losses: 

Defective  goods  manu- 
factured during  tlila 
period,  under  con- 
tract,  rejected  by 
customers : 

Cost    $5,675.00 

Less     esti- 

mated 

scrap  value    250.00 


Less  operating  gains, 
4%  on  cost  of  con- 
tracts, offered  by  the 


Surety  Co. 


$5,425.00 


2,892.00 


$2,533.00 


Loss  of  Appropriated  Surplus: 

Fines  incurred 
for  viola- 
t  i  o  n  s  of 
specifica- 
tions under 
contracts   .  .  $1,500.00 

Allowances  to 
customers 
for  claims 
under  con- 
tracts       3,600.00 


Total..  $5,100.00 

Less  Reserve 
for  Contract 
Contingen- 
cies     5,100.00 


Total  Losses $127,513.00 


$127,513.00 


Treatment  of  Reserves 

The  treatment  of  reserves  in  the  statement  of  affairs 
and  in  the  deficiency  account  is  twofold: 

1.  Reserves  may  be  deducted  from  the  book  value  of 
the  assets  in  order  that  the  remainder,  or  depreciated  book 
value,  when  compared  with  the  estimated  realization  may 
give  the  amount  of  the  true  loss  not  provided  for, 

2.  Reserves  may  be  treated  on  the  liability  side  of  the 
statement  as  appropriated  surplus,  and  deducted  in  the 
deficiency  account  from  the  estimated  losses  said  to  be 
due  to  forced  liquidation. 


THE    STATEMENT    OF    AFFAIRS  473 

Arrangement  of  the  Statement  of  Affairs 

The  arrangement  of  the  statement  is,  of  course,  a 
matter  of  personal  opinion,  since  we  are  dealing  with 
theory  not  consecrated  by  practice. 

1.  The  assets  may  be  shown  on  the  debit  side  or  on 
the  credit  side  of  the  statement. 

2.  The  statement  may  start  with  a  perfect  balance  by 
showing  in  the  "Book  Value"  column  all  the  open  ac- 
counts, debits  and  credits,  found  in  the  general  ledger; 
or  it  may  treat  only  of  assets  which  are  to  be  realized,  and 
of  liabilities  to  outsiders. 

3.  It  may  present  the  liabilities  in  the  order  given  in 
the  above  solution,  or  it  may  state  them  in  the  order  pre- 
scribed by  the  summary  of  debts  and  assets  to  be  pre- 
sented by  bankruptcy  petitioners ;  i.e. : 

1.  Preferred  Claims 

2.  Secured  Claims 

3.  Unsecured  Claims 

4.  Contingent  Liabilities 

5.  Accommodation  Paper 

Arrangement  of  Deficiency  Account 

As  to  the  deficiency  account,  any  arrangement  which 
fails  to  bring  it  down  to  the  level  of  accounting  under- 
standing possessed  by  the  average  layman,  and  requires 
expert  explanation  for  its  clear  comprehension,  is  to  be 
condemned  whether  we  deal  with  theory  or  with  practice. 

If  the  statement  of  affairs  ends  with  an  excess  of  free 
assets  over  and  above  the  amount  of  unsecured  claims, 
the  deficiency  account  can  still  be  made;  but,  instead  of 
showing  deficiency  to  meet  the  claims  of  outsiders,  it  is 
satisfactory  to  show  that  deficiency  which  measures  the 
impairment  of  the  capital  of  the  insiders,  be  they  sole 
traders,  copartners,  or  stockholders. 


CHAPTER  XL 

REALIZATION    AND    LIQUIDATION 

Method  of  Closing 

Concerns  in  voluntary  liquidation  close  their  books  in 
the  usual  manner.  As  the  assets  are  collected  the  amount 
of  the  proceeds  is  debited  to  cash  and  credited  to  the 
assets.  Excess  or  deficiency  of  proceeds  is  credited  or 
debited  to  the  surplus  to  be  distributed  to  the  stock- 
holders, or  to  the  capital  accounts  of  the  proprietors. 
The  liability  accounts  are  closed  as  the  individual  items 
are  liquidated;  any  gain  due  to  a  compromise  is,  of  course, 
credited  to  Surplus  or  to  Capital  account. 

When  all  the  assets  have  been  realized  and  all  the  lia- 
bilities liquidated,  the  only  accounts  remaining  on  the 
books  are,  the  Cash  account,  the  Capital  Stock  account, 
and  the  Surplus  account,  if  the  concern  is  a  corporation, 
or  the  Cash  account  and  the  capital  accounts  of  the  pro- 
prietors, if  the  concern  is  a  sole  proprietorship  or  a  co- 
partnership. 

In  the  case  of  copartnerships,  the  accounts  of  the 
partners  are  debited  with  the  cash  distributed  to  them 
individually.     This  closes  the  books. 

In  the  case  of  corporations,  the  Capital  Stock  account 
is  debited  with  the  par  of  the  shares  returned  by  the 
stockholders  for  cancellation,  and  the  Surplus  account  is 
debited  with  the  amount  which  the  stockholders  receive, 
in  the  ratio  of  the  shares  which  they  hold. 

474 


REALIZATION    AND    LIQUIDATION  475 

It  goes  without  saying  that  if  the  surplus  is  converted 
into  an  impairment  of  the  stock,  the  amount  of  the  im- 
pairment being  debited  to  the  Capital  Stock  account  re- 
duces the  latter  to  the  exact  amount  of  cash  available 
for  distribution. 

It  is  from  the  above  simple  closing  process  that  the 
"Statement  of  Realization  and  Liquidation"  has  been 
evolved.  It  is  not  a  practical  statement,  in  the  sense  that 
it  is  probably  never  used;  but  as  a  theoretical  statement 
it  has  the  great  advantage  of  testing  the  analytic  and  syn- 
thetic powers  of  the  student.  It  is  probably  for  that 
reason  that  the  New  York  Board  of  C.P.A.  Examiners 
has  given  the  statement  of  realization  and  liquidation  such 
prominence  in  their  examinations. 

Statement  of  Realization  and  Liquidation 

The  mechanism  of  this  statement  is  logic  pure  and 
simple.     It  must  show: 

1 .  The  individual  assets  to  be  realized 

2.  The  individual  liabilities  to  be  liquidated 

3.  The  amount  realized  on  the  assets 

4.  The  amount  paid  to  liquidate  the  debts 

5.  The  expenses  incident  to  the  realization  and  liqui- 

dation 

6.  The  assets  not  realized 

7.  The  liabilities  not  liquidated 

8.  The  gains  on  realization 

9.  The  losses  on  realization 

To  show  all  these  factors  in  a  single  account  and  bring 
them  to  a  balance,  requires  less  ingenuity  than  belief  in 
the  truth  of  accounting  principles  and  ability  to  handle 
delicate  accounting  mechanisms.  In  fact,  the  Realization 
and  Liquidation  account  is  practically  a  copy  of  the  trans- 
actions incident  to  the  liquidation,  so  arranged  as  to  make 
it  possible  for  a  reader  not  wholly  deficient  in  accounting 


476 


FINANCIAL    STATEMENTS 


knowledge,  to  perceive  at  a  glance  the  nature  of  the 
closing  operations.  If  the  statement  is  adequately  pre- 
pared, one  must  be  able  to  single  out  any  asset,  ascertain 
its  original  amount,  its  increase  during  liquidation,  the 
proceeds  of  its  sale,  and  the  gain  or  the  loss  made  on  its 
realization.  One  must,  besides,  be  in  a  position  to  obtain 
an  accurate  idea  of  the  aggregate  of  gains,  losses,  ex- 
penses, and  settlements  which  were  made  before  the  affairs 
of  the  concern  were  effectively  liquidated. 

Preparation  of  Realization  and  Liquidation  Account 

The  following  problem  and  its  solution  will  serve  as 
an  illustration  of  the  method  of  preparing  the  Realization 
and  Liquidation  account  and  the  principles  involved: 


Problem 
The  Concrete  and  Blue  Stone  Construction  Company 
finds  itself  in  the  position  of  having  to  liquidate,  owing  to 
its  inability  to  obtain  extension  of  credit  and  to  borrow 
money.    Its  books  show  at  January  30,  19 14: 


Cash $2,000.00 

Land  and  Buildings 30,000.00 

Plant  Equipment 22,600.00 

Materials    and    Supplies 

Inventory 8,100.00 

Contracts  in  Process 32,000.00 

Finished  Contracts 7,000.00 

Accounts  Receivable 5,400.00 

Bonds    of    Other    Com- 
panies     11,300.00 

General  and  Administra- 
tion Expense 9,34a5o 

Profit  and  Loss 1,600.00 


$129,340.50 


1st  Mortgage,  Land  and 
Building,  Interest  and 

Principal   $17,230.00 

Notes  Payable 12,300.00 

Sundry  Creditors 52,340.50 

Salaries   Due 2,350.00 

Taxes  Due i2aoo 

Capital  Stock  Outstand- 
ing   45,000.00 


$129,340.50 


The  account  "Finished  Contracts"  contains  charges 
representing  allowances  to  customers  for  unsatisfactory 


REALIZATION    AND    LIQUIDATION 


477 


contracts;  as  an  asset,  it  is  worthless.  The  accounts  re- 
ceivable represent  charges  made  by  the  company  against 
customers  for  what  the  company  calls  extra  work  not 
included  in  specifications;  of  the  whole  amount  $3,200  is 
disclaimed  by  customers,  and  will  probably  be  lost.  The 
bonds  of  other  companies  were  received  in  settlement  of 
contracts,  and  are  worth  about  $5,000.  They  are  pledged 
to  secure  $6,000  of  notes  payable.  The  account  "Con- 
tracts in  Process"  represents  cost  to  date;  the  amount 
to  be  received  by  the  company  when  the  contracts  are 
completed  is  $45,000;  but  it  is  estimated  that  it  will  re- 
quire $15,000  to  complete  said  contracts.  The  sureties 
on  the  contracts  will  provide  the  amount  required;  they 
purchase,  for  $6,350,  the  materials  and  supplies  held  by 
the  company,  and  apply  them  toward  the  completion  of 
the  contracts. 

The  Cash  account  shows,  at  March  30,  1914: 


Initial  Balance $2,000.00 

Sale  of  Land  and  Build- 
ings    29,150.00 

Sale  of  Plant  Equipment  15,165.40 

Sale  of  Materials  and 
Supplies 6,911.10 

Collection  of  Accounts 
Receivable 2,741.20 

Received    on    Contracts 

Finished  by   Sureties.  31,140.00 

Interest  Credited  on 
Bank  Balances 71.25 

Sale  of  Bonds 9,100.00 

$96,278.95 


Paid  on  Mortgage: 

Principal $17,000.00 

Interest   25a30 

Paid    for    Salaries    and 
Wages 2,350.00 

Paid  for  Taxes 120.00 

Paid  to  Creditors 52,340.50 

Paid  at  Maturity  of 
Notes  i2,3oaoo 

Paid    for    Expenses    of 
Liquidation 2,938.10 

Balance  Paid  to  Stock- 
holders      8,98ao5 

$96,278.95 


Required : 
The  Realization  and  Liquidation  account,  showing 
clearly  what  took  place. 


478 


FINANCIAL    STATEMENTS 


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48o 


FINANCIAL    STATEMENTS 


Principles  Involved 

The  foregoing  statement  may  properly  be  called  a 
synthesis  of  the  results  of  an  analysis.  It  presupposes  that 
the  account  "Realization  and  Liquidation"  is  raised  on 
the  books,  and  debited  with: 

1.  The  assets,  the  individual  accounts  with  which  are 

closed 

2.  The  new   assets  representing  additional  income 

during  liquidation 

3.  The  increase  of  assets  due  to  gains  in  realization 
and  credited  with: 

1.  The  liabilities,  the  individual  accounts  with  which 

are  closed 

2.  The  new  liabilities  representing  additional  income 

charges  during  liquidation 

While  this  supposition  is  not  true  in  practice,  it  is 
perfectly  plausible  in  theory,  and  results  in  gathering  into 
a  group  account,  all  the  assets  to  be  realized  and  all  the 
liabilities  to  be  liquidated.  At  this  point,  the  accounting 
begins:  It  must  show  on  the  credit  side  of  the  account, 
the  exact  amount  of  assets  which  the  first  section  enumer- 
ates in  detail  on  the  debit  side,  care  being  taken  to  differ- 
entiate between  proceeds  and  losses;  it  must  show  on  the 
debit  side  of  the  account,  the  exact  amount  of  liabilities 
which  the  first  section  enumerates  in  detail  on  the  credit 
side.  The  only  difficulty  to  be  overcome,  is  that  which  is 
presented  by  the  treatment  of  losses  and  expenses. 

The  losses  have  been  accounted  for  on  the  credit  side 
of  the  account.  This  is  as  it  should  be,  since  in  practice, 
they  would  be  credited  to  the  individual  assets  and  debited 
to  surplus.  But  also  in  practice,  debits  to  surplus  repre- 
sent losses  of  capital,  at  least  at  winding  up,  and  it  is 
therefore  evident  that  the  effect  of  such  losses  must  be 
recorded  in  the  realization  account.     Consequently,  they 


REALIZATION    AND    LIQUIDATION  48 1 

are  to  be  shown  as  deductions  from  the  liabiHty  of  the 
concern  to  the  stockholders.  The  same  is  true  of  expenses 
incident  to  hquidation.  Thus,  when  all  losses  and  ex- 
penses have  been  charged  to  capital  stock,  there  must 
remain  in  the  cash  account  a  balance  equal  to  the  balance 
of  the  stock  liability. 

Peter  Post  Problem 

The  Realization  and  Liquidation  account  is  simple 
enough  when  established  in  connection  with  concerns  at- 
tending to  the  liquidation  of  their  own  affairs.  In  recent 
years,  the  account  has  been  made  by  boards  of  C.P.A. 
examiners  to  apply  to  the  expression  of  the  results  of 
the  administration  of  receivers  appointed  to  rehabilitate 
concerns  financially  embarrassed.  When  carried  to  such 
heights,  the  account  is  extremely  difficult  to  establish, 
since  it  brings  about  accounting  for  the  multiple  muta- 
tions of  assets  due  to  operations.  Witness  the  following 
problem  given  at  the  New  York  C.  P.  A.  examination  of 
October,  1907: 

Problem 

The  affairs  of  Peter  Post,  a  manufacturer,  were  in  a 
very  critical  condition,  for,  although  he  had  an  unimpaired 
investment  of  $62,500,  and  his  books  showed  a  clear  in- 
crease of  $6,022,  he  owed  his  trade  creditors  $25,289  and 
had  only  $265  in  cash  and  $4,062  in  receivable  book 
accounts  on  which  to  rely  for  funds.  The  rest  of  his  busi- 
ness estate  was  tied  up  in  the  following  chattels  which  he 
had  acquired  in  an  effort  to  keep  pace  with  a  business 
growth  that  had  outrun  his  capital:  machinery  and  tools, 
$31,497;  raw  materials,  $18,838;  partly  made  goods, 
$31,562,  and  finished  wares,  $7,587.  It  was  also  neces- 
sary, in  order  to  continue  operations,  to  have  immediate 
cash  for  pay-rolls  and  incidental  expenses. 


482 


FINANCIAL    STATEMENTS 


A  meeting  of  his  principal  creditors  was  called,  and, 
as  it  appeared  that  the  business  was  well  established, 
profitable,  and  had  a  sure  and  growing  market,  they  de- 
cided to  advance  him  $6,000  in  cash  for  immediate  needs 
and  extend  his  credit  in  a  sufficient  amount  to  permit  of 
the  purchase  of  necessary  materials  and  generally  to  con- 
tinue operations  till  the  present  stock  of  materials  could 
be  made  up  and  realized  on. 

In  order  to  insure  the  proper  application  of  the  funds 
and  credit  so  provided,  a  trustee  was  appointed  to  ad- 
minister the  finances  till  the  creditors'  claims  were 
satisfied,  at  which  time  the  control  would  revert  to  the 
proprietor. 

The  subsequent  operations  under  the  trusteeship  were 
as  follows:  cash  paid  for  labor,  $15,725;  for  expenses, 
$5,430;  for  additional  tools,  $750;  purchases  on  book  ac- 
count, charged  to  materials,  $6,300;  to  expenses,  $15,000; 
sales  on  book  account,  $72,300;  loss  on  collection  of  book 
debts,  $380;  personal  drawings  of  Peter  Post,  $3,500. 

The  unliquidated  values  at  the  close  of  the  trusteeship 
were  as  follows:  inventory  of  raw  materials,  $5,000; 
finished  wares,  $27,900;  accounts  receivable  outstanding, 
$3,382;  and  accounts  payable,  $89. 

Prepare,  with  due  regard  to  the  grouping,  order,  and 
arrangement  of  the  items,  as  best  calculated  clearly  to 
display  the  facts,  (a)  realization  and  liquidation  account, 
(b)  trustee's  cash  account,  (c)  balance  sheet  of  business  as 
restored  to  Peter  Post. 


REALIZATION    AND    LIQUIDATION  483 

Solution 

Statement  of  the  Results  of  the  Administration  of 
Peter  Post 


BY ,  Trustee,  from to 

Section  I — Debit  Side 

Assets  Taken  from  Peter  Post: 

Cash  $265.00  ^ 

Accounts  Receivable 4,062.00 

Machinery  and  Tools 31,497.00 

Raw  Materials 18,838.00 

Goods  in  Process 31,562.00 

Finished  Goods 7,587.00      $93,811.00 

New  Assets  Obtained  During  Trusteeship: 

Cash — Loan  by  Creditors $6,000.00 

Tools — Purchased  for  Cash 7SO.oo 

Raw  Materials — Purchased  on  Credit 6,300.00 

Sundry  Supplies — Purchased  on  Credit 15,000.00 

Manufacturing  Labor — Paid  in  Cash 15,725.00 

Finished  Goods — Completed  by  Trustee 82,425.00 

Accounts  Receivable — Sales  by  Trustee 72,300.00      198,500.00 

Total  Assets  Taken  Over  and  Acquired $292,311.00 

Operating  Gains  Made  by  Trustee: 
Excess  of  Proceeds  of  Trading  Assets  Over  Cost 
Thereof : 

Proceeds    (Sales) $72,300.00 

Less  Cost  of  Goods  Sold : 

Cost    of    Goods    Completed    (see 

contra)  $82,425.00 

Less    Increase    of    Inventory    of 
Finished  Goods 20,313.00 

Cost  of  Goods  Sold 62,112.00       10,188.00 

Total  with  which  Trustee  is  chargeable $302,499.00 


484  FINANCIAL    STATEMENTS 

Statement  of  Results — Continued 
Section  II — Debit  Side 

Disposal  of  Liabilities: 

1.  Liabilities  Liquidated: 

Trade  Creditors $52,500.00 

2.  Liabilities  Returned  to  Peter  Post: 

Trade  Creditors 89.00 

Total $52,589.00 

Total  Section  II $52,589.00 

Total  Sections  I  and  II,  Debit  Side $355,088.00 

Section  i — Credit  Side 

Liabilities  Taken  Over: 

Due  to  Trade  Creditors $25,289.00 

New  Liabilities  Incurred  During  Trusteeship : 
Accounts  Payable: 
Trade  Creditors : 

For  Cash  Loan $6,000.00 

"    Raw  Materials 6,300.00 

"    Sundry  Supplies 15,000.00       27,300.00 

Total  to  be  credited  to  Trustee $52,589.00 

Section  II — Credit  Side 

Disposal  of  Assets: 

1.  Transformed  by  Manufacturing  Process: 

Goods  in  Process,  Initial  Inventory $31,562.00 

Raw   Materials 20,138.00 

Sundry  Manufacturing  Supplies 15,000.00 

Factory  Labor 15,725.00 

Total  $82,425.00 

2.  Sold  by  Trustee  (Finished  Goods,  Sale  Price) ,,,,,,      72,300.00 


REALIZATION    AND    LIQUIDATION  485 

Statement  of  Results — Continued 

3.  Expended  by  Trustee : 

To  Liquidate  Liabilities $52,500.00 

"    Purchase  Tools 750.00 

"    Pay  for  Manufacturing  Labor 15,725.00 

Pay  for  Expenses 5430.00 

For  Advances  to  Proprietor,  Peter  Post 3,500.00 

Total  $77,905.00 

4.  Lost  in  Collection : 

Accounts   Receivable 380.00 

5.  Returned  to  Peter  Post,  Proprietor : 

Cash $96aoo 

Accounts   Receivable 3,382.00 

Machinery  and  Tools 32,247.00 

Goods  in  Process  (None) 

Finished  Goods 27,900.00 

Raw  Materials 5,000.00 

Total 69489.00 

Total  Section  II $302,499.00 

Total  Sections  I  and  II,  Credit  Side $355,088.00 


It  will  be  noticed  that  the  above  solution  presents,  in 
one  single  account,  all  the  requirements  of  the  problem, 
i.e.,  the  trustee's  administration  of  the  affairs  of  Peter 
Post,  the  trustee's  cash  account,  and  the  balance  sheet 
of  the  business  as  restored  to  Peter  Post,  the  latter  ex- 
cluding the  capital  account  of  the  proprietor,  which  can 
readily  be  ascertained  by  deducting  $89  from  $69,489,  i.e., 
$69,400.  As  the  proprietor's  capital  was  originally 
$68,522,  as  indicated  by  Section  i  of  the  account  of  the 
trustee's  administration,  it  becomes  evident  that  the  in- 
crease of  Peter  Post's  equity  in  his  assets,  i.e.,  $878,  has 
been  obtained  by  the  trustee  as  follows; 


4S6 


HNANCIAL    STATEMENTS 


Credit: 

Operating  Gain. $10,188.00 

Debits: 

Losses  of  Capital $380.00 

Expenses  of  Administration 5,430.00        5,810.00 

Net  Gain $4,378.oo 

Advanced  to  Proprietor 3,Soo.oo 

Increase  of  Capital  during  Trusteeship $878.00 


As  to  the  principles  underlying  the  account,  they  are 
better  understood  when  the  entries  recorded  in  the  ac- 
count with  the  trustee  are  worked  in  conjunction  with 
the  account  of  the  proprietor. 

What  the  proprietor  transfers  to  the  trustee,  is  nothing 
more  than  his  equity  in  his  assets,  represented  by  the 
assets  less  the  liabilities  to  outsiders.  Subsequently,  all 
the  new  assets  which  are  obtained  by  the  trustee,  and  all 
the  increases  of  assets  must,  of  necessity,  be  reflected  in 
the  proprietor's  account,  and,  as  a  consequence,  in  the 
trustee's  account.  Similarly,  all  decreases  of  assets  and 
all  increases  of  liabiHties  must  be  reflected  in  the  two 
accounts.  In  other  words,  by  a  series  of  debits  and  credits, 
the  two  accounts  exhibit,  step  by  step,  the  result  of  the 
transactions  which  took  place,  (i)  at  the  time  of  the 
transfer  of  assets  by  the  proprietor,  (2)  pending  the 
trustee's  administration,  (3)  at  the  time  of  the  discharge 
of  the  trustee.  Thus,  the  proprietor's  account,  which 
might  in  all  propriety  appear  on  the  books  of  the  trustee 
if  the  latter  kept  separate  books,  would  show: 


REALIZATION    AND    LIQUIDATION 


487 


Proprietor's  Account 
Books  of  the  Trustee 


Liabilities  taken  over  by 

the  Trustee $25,289.00 

Proprietor's  Equity 68,522.00 


$93,811.00 


New  Liabilities  incurred 
by  Trustee $27,300.00 

Losses  made  by  Trustee.        380.00 

Expenses  of  the  Trus- 
tee       5430.00 

Advances  by  Trustee 3,500.00 

Assets  consumed  by 
Trustee 82425.00 

Assets  sold  by  Trustee..  72,300.00 

Assets  expended  by 
Trustee 68,975.00 

Assets  returned  by  Trus- 
tee    69489.00 


$329,79900 


Assets  taken  over  by  the 
Trustee $93,811.00 


$93,811.00 


Proprietor's  Equity $68,522.00 

New  Assets  acquired  by 

Trustee 198,500.00 

Gains  made  by  Trustee. .  10,188.00 
Liabilities    liquidated   by 

Trustee 52,500.00 

Liabilities     returned     by 

the  Trustee. 89.00 


$329,79900 


It  is  true,  of  course,  that  in  practice  the  proprietor's 
account,  if  kept,  would  only  contain  the  following  entries: 

Debits 
Liabilities  taken  over. .  .$25,289.00 
Proprietor's  Equity 68,522.00 


$93,811.00 


Losses $380.00 

Expenses 5.430.oo 

Advances 3,Soo.oo 

Assets  returned 69,489.00 

$78,79900 


Credits 
Assets  taken  over $93,811.00 


$93,811.00 


Proprietor's  Equity $68,522.00 

Gains 10,188.00 

Liabilities  returned. 89.00 


$78,79900 


488 


FINANCIAL    STATEMENTS 


But  we  must  not  forget  that,  according  to  accounting 
principles,  crediting  the  proprietor  with  gain  is  equivalent 
to  crediting  him  with  the  assets  which  he  has  received 
and  debiting  him  with  the  assets  with  which  he  has  parted 
to  obtain  that  gain;  that  the  same  is  true  of  losses;  that 
debiting  the  proprietor  with  expenses  is  equivalent  to 
debiting  him  with  the  assets  with  which  he  has  parted, 
instead  of  with  the  cost  of  the  benefits  which  he  has  re- 
ceived through  the  incurrence  of  such  expense. 

Returning  to  the  solution  of  the  above  problem,  the 
reader  may  perhaps  ask  why  the  factory  labor  expended 
for  the  manufacture  of  goods  is  to  be  charged  to  the 
trustee,  as  representing  an  asset.  If,  however,  he  will  bear 
in  mind  that  all  the  items  contributing  to  cost  of  goods 
manufactured  for  sale  are  assets  until  the  goods  are  sold, 
and  can  in  nowise  be  treated  as  expense,  he  will  answer  his 
own  question. 

The  following  solution  of  the  Peter  Post  problem  was 
submitted  to  the  author  by  a  practising  accountant  as 
fulfilling  its  requirements.  The  solution  illustrates  the 
twist  which  may  be  given  to  the  theory  of  accounts. 


Peter  Post 
Statement  of  Realization  and  Liquidation 


Assets  to  be  Realized 

Per  Balance  Sheet: 

Machinery  and  Tools. .  .$31,497.00 

Goods  in  Process 31,562.00 

Materials 18,838.00 

Finished  Goods 7,587.00 

Accounts  Receivable. . . .     4,062.00 

New  Assets: 

Accounts  Receivable 72,300.00 

Tools 750.00 


Liabilities  to  be  Liquidated 

Per  Balance  Sheet: 

Accounts  Payable $25,289.00 


New  Liabilities: 

Accounts  Payable 27,300.00 


REALIZATION    AND    LIQUIDATION  489 

Statement  of  Realization  and  Liquidation — Continued 


Liabilities  Not  Li  qui - 

dated: 
Accounts  Payable 

Liabilities  Liquidated: 
Accounts  Payable . . 


89.00 


52,500.00 


Supplementary  Charges: 

Materials  25,138.00 

Labor  15,725.00 

Expense 20430.00 

Goods  in  Process 31,562.00 

Finished  Goods 7,587.00 

Losses  on  Accounts  Re- 
ceivable          380.00 

Peter  Post  drawings 3,500.00 

Profit  on  Realization  and 
Liquidation 878.00 

$324,385.00 


Assets  Not  Realized: 

Machinery  and  Tools . . .  32,247.00 

Accounts  Receivable 3,382.00 

Assets  Realized: 

Materials 18,838.00 

Goods  in  Process 31,562.00 

Finished  Goods 7,587.00 

Accounts  Receivable 72,600.00 

Losses  on  Realization: 

Accounts  Receivable 380.00 

Supplementary  Credits: 

Sales 72,300.00 

Inventory — Materials  .. .  5,000.00 
Inventory  —  Finished 

Goods   27,900.00 


$324,385.00 


Trustee's  Cash  Account 


Balance $265.00 

Creditors   (Loan) 6,000.00 

Accounts  Receivable 72,600.00 


$78,865.00 


Balance  $96aoo 


Labor  $15,725.00 

Expenses  5430.oo 

Tools   750.00 

Accounts  Payable 52,500.00 

Drawings  Peter  Post...     3»50o.oo 
Balance 960.00 


$78,865.00 


490 


FINANCIAL    STATEMENTS 
Balance  Sheet 


Assets 

Machinery  and  Tools. .  .$32,247.cx) 
Materials  and  Supplies..     5,000.00 

Finished  Goods 27,900.00 

Cash  960.00 

Accounts  Receivable....     3,382.00 


$69,489.00 


Liabilities  and  Capital 

Accounts  Payable $89.00 

Capital  62,500.00 

Surplus : 
Prior     to     ap- 
pointment of 

Trustee $6,022.00 

Profit  and  Loss 
o  f  Realiza- 
t  ion  and 
Liquidation.  4,378.00 


$10,400.00 
Drawings. . . .    3,500.00    6,900.00 


$69,489.00 


It  will  be  noticed  that  the  foregoing  solution  charges 
the  trustee,  under  what  is  called  "Supplementary 
Charges,"  with : 

Losses  of  Accounts  Receivable. . .  .$      380.00 
Expense  of  Realization 20,430.00 


or  a  total  of $20,810.00 

with  which  he  cannot  be  charged  under  any  rules  of  ac- 
counting, and  that  it  carries  inconsistency  to  the  extent 
of  debiting  the  trustee  with  profit  on  realization.  No 
matter  how  lightly  one  may  treat  accounting  principles, 
a  trustee  cannot  be  charged,  at  the  same  time,  with  profits 
and  losses.  As  to  charging  the  trustee  with  the  drawings 
of  the  proprietor,  it  is  outside  of  the  limits  of  possibilities. 
Nothing  but  strict  adherence  to  principles  will  satisfy 
accounting  requirements. 


CHAPTER  XLI 
THE  ACCOUNTS  OF  FIDUCIARIES 

Academic  Theories 

In  the  course  of  accounting  instruction  as  offered  to- 
day, some  prominence  is  given  to  so-called  "Accounts  of 
Executors."  When  reduced  to  its  accounting  expression, 
such  a  course  consists  of  Httle  more  than  a  differentiation 
between  principal  and  income,  general  data  about  the 
duties  of  executors  to  the  estate,  and  laboratory  work 
upon  the  schedules  to  be  presented  by  the  fiduciary  in  final 
accounting. 

In  differentiating  between  principal  and  income,  the 
chief  principles  of  the  law  are  given  as  the  standard  by 
which  the  accounting  facts  will  be  judged.  This,  of  course, 
is  as  it  should  be;  but  unfortunately,  the  courts  have  not 
always  been  willing  to  accept  the  views  of  accountants 
upon  matters  relating  to  the  interests  of  the  life-tenant 
as  opposed  to  the  interests  of  the  remainderman. 

In  treating  of  the  accounts  of  the  testamentary 
trustee,  a  complete  set  of  books  is  usually  evolved,  and 
the  student  is  carefully  taught  to  debit  cash  and  to  credit 
the  estate;  to  credit  cash  and  to  debit  the  estate,  etc.,  etc. 
Special  forms  are  submitted,  which  are  said  to  have  re- 
sulted from  the  best  thought  of  men  who  have  spent  their 
lives  in  the  treatment  of  the  accounts  of  fiduciaries. 

Statutory  Provisions 

Coming  down  to  facts,  we  find  that  American  statutes 
prescribe  no  uniform  accounting  for  executors;  that  these 

491 


492  FINANCIAL    STATEMENTS 

trustees  may  keep  their  books  precisely  as  they  will,  pro- 
vided they  are  able  to  account  properly  to  the  court  for 
their  administration  of  the  estate.  What  the  law  does 
attempt  to  regulate,  is  the  interpretation  to  be  given  to 
the  word  "assets,"  that  is  to  say,  what  shall  be  included 
in  the  inventory  to  be  filed  by  the  executor  and  be  subse- 
quently accounted  for  by  him. 

Section  2714  of  the  New  York  Code  of  Civil  Proce- 
dure, given  below,  provides  that  the  assets  to  be  inven- 
toried are  the  personal  assets  of  the  deceased. 

"The  inventory  must  contain  a  particular  statement  of 
all  bonds,  mortgages,  notes,  and  other  securities  for  the 
payment  of  money  belonging  to  the  deceased,  known  to 
the  executor  or  administrator;  with  the  name  of  the 
debtor  in  each  security,  the  date,  the  sum  originally  pay- 
able; the  indorsements  thereon,  if  any,  with  their  dates 
and  the  sum  which,  in  the  judgment  of  the  appraisers,  is 
collectable  on  each  security;  and  of  all  moneys,  whether 
in  specie  or  bank  bills,  or  other  circulating  medium,  be- 
longing to  the  deceased,  which  have  come  to  the  hands 
of  the  executor  or  administrator,  and  if  none  have  come 
into  his  hands,  the  fact  shall  be  stated  in  the  inventory. 

"The  naming  of  a  person  executor  in  a  will  does  not 
operate  as  a  discharge  or  bequest  of  any  just  claim  which 
the  testator  had  against  him;  but  it  must  be  included 
among  the  credits  and  effects  of  the  deceased  in  the  in- 
ventory, and  the  executor  shall  be  liable  for  the  same  as 
for  so  much  money  in  his  hands  at  the  time  the  debt  or 
demand  becomes  due,  and  he  must  apply  and  distribute 
the  same  in  the  payment  of  debts  and  legacies,  and  among 
the  next  of  kin  as  part  of  the  personal  property  of  the  de- 
ceased. The  discharge  or  bequest  in  a  will  of  a  debt  or 
demand  of  the  testator  against  an  executor  named  therein, 
or  against  any  other  person,  is  not  valid  as  against  the 
creditors  of  the  deceased;  but  must  be  construed  only  as 


THE    ACCOUNTS    OF    FIDUCIARIES  493 

a  Specific  bequest  of  such  debt  or  demand;  and  the  amount 
thereof  must  be  included  in  the  inventory  and,  if  necessary, 
be  applied  in  the  payment  of  his  debts;  and  if  not  necessary 
for  that  purpose,  must  be  paid  in  the  same  manner  and 
proportion  as  other  specific  legacies. 

"If  personal  property  not  mentioned  in  any  inventory 
come  to  the  possession  or  knowledge  of  an  executor  or 
administrator,  he  must  cause  the  same  to  be  appraised  as 
herein  required,  and  an  inventory  thereof  to  be  returned 
within  two  months  after  the  discovery  thereof;  and  the 
making  of  such  inventory  and  return  may  be  enforced  in 
the  same  manner  as  in  the  case  of  a  first  inventory." 

Executor's  Accounting 

It  is  around  the  inventory,  as  filed,  that  the  accounting 
of  the  executor  to  the  courts  revolves.  He  must  charge 
himself  with  the  increases  of  that  inventory,  and  such  in- 
creases automatically  become  part  of  the  total  to  be 
accounted  for.  It  is  not  with  the  net  of  the  increases,  after 
the  deduction  of  losses  from  gains,  that  the  executor  must 
charge  himself,  but  with  the  gross  amount.  As  to  the 
decreases,  he  must  explain  them  in  full  in  a  separate  part 
of  his  account. 

As  will  be  noticed,  the  section  of  the  law  quoted  above, 
refers  only  to  personal  property.  As  a  matter  of  principle, 
the  executor  has  no  right  whatever  to  the  possession  of 
real  estate,  unless  it  be  specifically  devised  to  him  in  trust. 
If,  however,  it  is  necessary  for  the  executor  to  collect 
rentals,  or  to  sell  the  real  estate  in  order  to  pay  the  debts 
of  the  testator,  the  executor  of  the  estate  may  derive  from 
the  statutes,  or  from  the  will  itself,  sufficient  authority 
to  proceed. 

The  accounting  by  the  executor  is  essentially  a  matter 
of  schedules,  which  will  be  given  in  the  course  of  the 
present  chapter;  but  his  administration  of  the  estate  is 


494  FINANCIAL    STATEMENTS 

subjected  by  law  to  certain  rules  which  he  must  apply  for 
the  protection  of  all  parties  at  interest,  including  himself. 
He  must  support,  by  proper  vouchers,  all  disbursements 
which  he  makes  over  and  above  an  amount  of  $20;  and 
the  sum  of  small  payments  not  supported  by  proper 
vouchers  must  not  exceed  $500.  If,  however,  a  voucher 
for  any  sum  disbursed  has  been  lost  or  accidentally  de- 
stroyed, the  sworn  statement  of  the  payee,  coupled  with 
the  justification  for  the  expenditure,  will  discharge  the 
executpr.  As  evidenced  by  the  order  of  the  schedules 
which  he  must  submit,  the  classes  of  disbursements  which 
the  executor  is  empowered  to  make  are  as  follows: 

1.  Funeral  and  administration  expenses 

2.  The  payment  of  debts  owed  by  the  deceased 

3.  The  payments  to  legatees,  widow,  or  next  of  kin 

for  their  share  of  the  estate  as  per  the  will 

Payment  of  Debts  and  Legacies 

As  to  the  payment  of  the  debts  of  the  deceased,  the 
debts  preferred  by  statute  must  be  paid  first,  and  with 
proper  diHgence.    Generally  speaking,  these  debts  are: 

1.  Duties  to  the  Federal  Government  on  imported 

goods,  etc. 

2.  Taxes  assessed  upon  the  property  of  the  decedent 

3.  Docketed  judgments 

The  order  in  which  these  classes  of  debts  are  to  be 
paid  is  precisely  that  given  above;  the  executor  must  pay 
one  class  entirely  before  he  may  proceed  to  the  others; 
he  must  first  pay  the  debts  due,  but  he  may  simulta- 
neously pay  debts  not  as  yet  matured,  provided  he  deducts 
therefrom  interest  to  the  maturity  of  the  debt. 

As  to  all  the  other  debts,  they  constitute  a  fourth  class 
and  are  paid  according  to  their  maturity.  It  must  be 
stated,  however,  that  a  real  estate  mortgage  cannot  be 
paid  out  of  the  personal  estate  unless  the  will  has  so  pro- 


THE    ACCOUNTS    OF    FIDUCIARIES 


495 


vided ;  and  it  must  also  be  borne  in  mind  that  the  executor 
has  no  right  to  pay  or  to  revive  a  debt  which  has  been 
barred  by  the  statute  of  Hmitations. 

Concerning  legacies,  the  executor  must  not  pay  them 
before  the  expiration  of  one  year,  unless  the  will  provides 
otherwise.  But  even  in  this  case  the  legacy  is  paid  subject 
to  a  bonded  liability  of  the  legatee  contingent  upon  the 
sufficiency  of  the  remainder  of  the  estate  to  pay  the  debts 
of  the  testator. 

The  Executor's  Compensation 

In  the  State  of  New  York  the  law  provides  for  the 
compensation  of  testamentary  trustees  in  all  cases  where 
the  will  has  not  specially  provided  therefor,  or  where  the 
executor  has  legally  renounced  the  compensation  assigned 
to  him  by  the  will.  The  amount  of  such  legal  compensa- 
tion, or,  as  it  is  more  frequently  termed,  "commissions,"  is, 
generally  speaking,  computed  on  the  amounts  received  and 
paid  out.    The  rate  is  : 

On  a  sum  not  exceeding  $i,ooo 5% 

On  a  second  sum  not  exceeding  $10,000  2^% 
On  the  remainder,  above  $11,000 1% 

While  it  is  a  recognized  principle  that  where  more 
than  one  executor  is  named,  each  executor  receives  com- 
missions according  to  the  services  which  he  renders,  there 
is  a  provision  made  by  the  New  York  law  for  the  com- 
pensation of  each  executor  of  an  estate  valued  at  $100,000 
or  more  in  personal  property  over  and  above  all  debts. 
In  such  cases  each  executor  is  entitled  to  the  full  commis- 
sion allowed  when  only  one  executor  administers  the 
estate.  If,  however,  there  are  more  than  three  executors, 
the  compensation  to  which  three  would  be  entitled  alto- 
gether, must  be  divided  among  all  according  to  the  value 
of  the  services  r^ndere4  by  them  individually. 


496  FINANCIAL    STATEMENTS 

Form  of  Executor's  Account 

The  following  form  of  the  account  of  an  executor  is 
in  vogue  in  the  Court  of  the  Surrogate  of  the  County  of 
New  York: 

Surrogate's  Court, 

County  of  New  York. 


In  the  matter  of  the  judicial  settlement 

of  the  account  of  M.  T.  Fordham, 

of  New  York, 

deceased 


To  the  Surrogate  of  the  County  of  New  York : 

I,  A.  Abner,  of  the  City  of  New  York,  in  the  County  of  New  York, 
do  hereby  render  the  following  account  of  the  proceedings  as  the 
executor  of  the  estate  of  the  said  deceased. 

On  the day  of ,  A.  D.,  191. .,  I  caused  an  inventory  of  the 

personal  estate  of  the  said  deceased  to  be  filed  ii  the  office  of  the 
Surrogate  of  the  County  of  New  York,  which  personal  estate  therein 
set  forth  amounts,  by  appraisement  by  the  appraisers  duly  appointed,  to 
$13,610.20. 

Schedule  A,  hereto  annexed,  contains  a  statement  of  all  the  prop- 
erty contained  in  said  inventory,  sold  by  me  at  public  or  private  sale, 
with  the  prices  and  manner  of  sale;  which  sales  were  fairly  made  by 
me  at  the  best  prices  that  could  then  be  had  with  due  diligence,  as  I 
then  believed;  it  also  contains  a  statement  of  all  the  debts  due  the 
said  estate  and  mentioned  in  said  inventory,  which  have  been  collected, 
and  also  of  all  interest  or  moneys  received  by  me  for  which  I  am 
legally  accountable. 

Schedule  B,  hereto  annexed,  contains  a  statement  of  all  debts  in 
said  inventory  mentioned,  not  collected  or  collectable  by  me,  together 
with  the  reasons  why  the  same  have  not  been  collected  and  are  not 
collectable ;  and  also  a  statement  of  the  articles  of  personal  property 
mentioned  in  said  inventory,  now  unsold,  and  the  reasons  of  the  same 
being  unsold,  and  their  appraised  value ;  and  also  a  statement  of  all 
property  mentioned  therein,  lost  by  accident,  without  any  wilful  default 
or  negligence,  the  cause  of  its  loss  and  its  appraised  value.  No  other 
assets  than  those  in  said  inventory,  or  herein  set  forth,  have  come  to 
my  possession  or  knowledge,  and  all  the  increase  or  decrease  in  the 
value  of  any  assets  of  said  deceased  is  allowed  or  charged  in  said 
Schedules  A  and  B. 

Schedule  C,  hereto  annexed,  contains  a  statement  of  all  moneys 
paid  by  me  for  funeral  and  other  necessary  expenses  for  said  estate, 
together  v/ith  the  re?t50ns  and  object  of  such  expenditure. 


THE    ACCOUNTS    OF    FIDUCIARIES  497 

On  or  about  the  ....  day  of in  the  year  191 . .,  I  caused 

a  notice  for  claimants  to  present  their  claims  against  the  said  estate  to 
me  within  the  period  fixed  by  law,  and  at  a  certain  place  therein 
specified,  to  be  published  in  two  newspapers,  according  to  law,  for  six 
months,  pursuant  to  an  order  of  the  Surrogate  of  the  County  of  New 
York,  to  which  order,  notice,  and  due  proof  of  publication  herewith 
filed,  I  refer  as  part  of  this  account. 

Schedule  D,  hereto  annexed,  contains  a  statement  of  all  the  claims 
of  creditors  presented  to  and  allowed  by  me  or  disputed  by  me  and  for 
which  a  judgment  or  decree  has  been  rendered  against  me,  together 
with  the  names  of  the  claimants,  the  general  nature  of  the  claim,  its 
amount,  and  the  time  of  the  rendition  of  the  judgment;  it  also  contains 
a  statement  of  all  moneys  paid  by  me  to  the  creditors  of  the  deceased, 
and  their  names,  and  the  time  of  such  payment. 

Schedule  E,  hereto  annexed,  contains  a  statement  of  all  moneys  paid 
to  the  legatees,  widow,  or  next  of  kin  of  the  deceased. 

Schedule  F,  hereto  annexed,  contains  the  names  of  all  persons 
entitled  as  widow,  legatee,  or  next  of  kin  of  the  deceased,  to  a  share 
of  his  estate,  with  their  places  of  residence,  degree  of  relationship,  and 
a  statement  of  which  of  them  are  minors,  and  whether  they  have  any 
general  guardian,  and,  if  so,  their  names  and  places  of  residence,  to  the 
best  of  my  knowledge,  information,  and  belief. 

Schedule  G,  hereto  annexed,  contains  a  statement  of  all  other  facts 
affecting  the  administration  of  said  estate,  his  rights,  and  those  of 
others  interested  therein. 

I  charge  myself  as  follows: 

With  amount  of  inventory $ 

"  increase,  as  shown  by  Exhibit  A 

Total $ 

I  credit  myself  as  follows : 

With  amount  of  loss  on  sales,  as  per  Schedule  B $ 

"  debts  not  collected,  as  per  Schedule  B 

Schedule  C 

Schedule  D 

Schedule  E 

Total $ 

Leaving  a  balance  of $ 

to  be  distributed  to  those  entitled  thereto,  subject  to  the  deductions  of 
the  amount  of  commissions,  and  the  expenses  of  this  accounting.  The 
said  schedules,  which  are  signed  by  me,  form  part  of  this  account. 


498 


FINANCIAL    STATEMENTS 


Schedule  A 


Sales  of 
Cash — From  Whom         Property 
Received  and  All  and  Debts  Rents  Interest  Dividends  Total 

Necessary  Information        Due 

Deceased 
U.  S.  Mortgage  and  Trust 
Co. — Cash  on  Deposit. . 
Dime  Savings  Bank — Cash 

on  Deposit 

N.  Y.  Life  Insurance  Co. — 

Policy  No ,  payable 

to  estate 

Browner    &    Simplex — Sal- 
ary due  testator 

J.  Spruce — Promissory  note 

due  this  day 

S.  Turner — Mortgage  Bond, 
Principal  and  Interest... 
Unknown  —  50     shares     of 
Bacillac  Co.,  Dividend  de- 
clared thereon — on 

Unknown — Personal    wear- 
ing apparel 

(Signed)  A.  Abner, 

Executor  of  the  Estate  of 

M.  T.  Fordham,  deceased. 

Schedule  B  (4  Parts)  Part  i 

Property  Mentioned  in  Inventory,  Lost  by  Accident  Without  Any  Wilful 
Default  or  Negligence ;  the  Cause  of  Its  Loss  and  Appraised  Value 

(None) 

Schedule  B  Part  2 

Decrease  of  the  Value  of  Any  Assets  of  Deceased  Mentioned  in 

Inventory 

(None) 

Schedule  B  Part  3 

Debts    Mentioned    in    Inventory    Not    Collected    or    Collectable,    With 

Reasons  Why  They  Have  Not  Been  Collected  and  Are  Not 

Collectable,  and  Their  Appraised  Value 

(None) 

Schedule  B  Part  4 

Personal  Property  Mentioned  in  Inventory  Unsold ;  and  the  Reasons  of 

the  Same  Being  Unsold,  and  Its  Appraised  Value 

(None) 


THE    ACCOUNTS    OF    FIDUCIARIES 


499 


Schedule  C,  D,  and  E 


Names 


Schedule  C  Schedule  D  Schedule  E 


Cash— To  Whom  Paid,  with 

Reasons  and  Object  of 

Expenditure 

Unknown — Funeral  Expenses 
— Legal  Expenses. . . 

Sundry — Executor's  Expenses 

Unknown  —  Rent  of  Apart- 
ment   

T.  B.  Roe,  M.D.,  Profes- 
sional services  to  testator. . 

Universal  Pharmacy  —  Drugs 
for  testator 

Miss  Spence  —  Professional 
services  to  testator 

Anna  Fordham  —  Sister  of 
deceased  

Mary  Fordham  —  Mother  of 
deceased 


Expenses 


Debts 

Owed 

by  the 

Deceased 


Paid  to 
Legatees, 
Widow,  or     t^.  < 

Next  of       T®**^ 

Kin  of 
Deceased 


(Signed)  A.  Abnek, 

Executor  of  the  Estate  of 

M.  T.  Fordham,  deceased. 


Schedule  F  (2  Parts)  Part  i 

Persons  Entitled  as  Widow,  Legatee,  y.  , 

or  Next  of  Kin  to  the  Deceased  to  a    Residence  u  ,  ?^^^  P- 

Share  of  the  Estate  Relationship 

Anna    Fordham Testator's  Sister 

Mary    Fordham Testator's  Mother 

George  Tesley Testator's  Nephew 

Ruth  Tesley Testator's  Niece 

(Signed)  A.  Abner, 

Executor  of  the  Estate  of 

M.  T.  Fordham,  deceased. 

Schedule  F  Part  2 

Names  of  Minors  Name  of  Guardian        Residence  of  Guardian 

(None) 


500  FINANCIAL    STATEMENTS 

Schedule  G 

Statement  of  All  Other  Facts  Aflfecting  the  Estate  Not  Included  in  Any 
Other  Schedule 

Commissions  Claimed  by  A.  Abner,  Executor : 

5%  on-  1st $1,000.00 

2j4%  on  next  10,000.00 

1%  on  balance 

(Signed)  A.  Abner, 

Executor  of  the  Estate  of 

M.  T.  Fordham,  deceased. 

Contents  of  Schedules 

It  will  be  noticed  that  Schedule  A  contains : 
In  the  first  column: 

The  proceeds  of  the  sale  of  the  corpus  of  the  estate; 
hence,  the  column  contains  the  corpus  as  repre- 
sented by  the  inventory  filed,  the  increases  of  such 
inventory  through  sales,  and  also  the  decreases 
thereof  through  sales. 
In  the  second  column: 

The  income  derived  from  the  real  estate  which,  either 
under  the  provisions  of  the  will  or  through  the 
necessities  of  the  estate,  has  come  within  the  con- 
trol of  the  executor. 
In  the  third  and  fourth  columns: 
The  other  income  earned  by  the  estate. 

This  means  that,  in  order  to  charge  the  executor  with 
the  increase  of  the  inventory,  it  is  necessary  to  refer  to 
the  said  inventory,  and,  by  comparison,  to  single  out  the 
particular  items  the  proceeds  of  which  have  been  greater 
than  their  appraised  value. 

As  to  the  losses  on  sale,  represented  by  the  excess  of 
the  appraisal  over  the  proceeds,  they  are  stated  in  Sched- 
ule B,  which  is  all  the  more  interesting  because  it  shows: 


THE    ACCOUNTS    OF    FIDUCIARIES  501 

1.  That  the  class  of  losses  referred  to  in  the  summary 

as  "Losses  on  Sales"  is  actually  composed  of 
two  classes  of  losses: 

a.  Losses  due  to  accidents  or  to  causes  over 

which  the  care  and  prudence  of  the  executor 
have  no  control 

b.  Losses  due  to  insufficiency  of  proceeds  when 

compared  with  the  appraisal  made  at  in- 
ventory time 

2.  That  the  class  of  items  referred  to  in  the  summary 

as  "Debts  Not  Collected,"  is  actually  composed 
of  two  classes  of  facts: 

a.  Debts  not  collected,  or  not  collectable 

b.  Inventory  items  not  sold 

Differentiation  Between  Principal  and  Income 

The  question  of  differentiation  between  principal  and 
income,  as  affecting  the  rights  of  life-tenants  and  remain- 
dermen, is  primarily  one  of  investment  accounting.  It 
arises  only  in  cases  where  the  funds  out  of  which  the  in- 
come of  the  life-tenant  is  to  be  paid,  have  been  invested 
in  securities  subsequent  to  the  death  of  the  testator. 

When  accountants  have  presented  their  interesting 
and  highly  commendable  arguments  in  favor  of  the  judicial 
interpretation  of  wills  according  to  scientific  principles, 
it  remains  true  that  courts  will  insist  upon  an  interpreta- 
tion which  is  in  accordance  with  the  intent  of  the  testator. 
If  he  intended  that  the  face  value  of  coupons  of  interest 
be  paid  to  the  life-tenant,  and  such  intention  is  made  clear 
by  the  terms  of  the  will,  or  by  the  surrounding  circum- 
stances and  conditions,  it  would  be  unfair  to  deduct  from 
the  proceeds  of  these  coupons  a  sum  which  at  compound 
interest  would  return  to  the  funds  of  the  remainderman 
the  premium  paid  by  the  executor  on  the  interest-bearing 
bonds. 


INDEX 


Accountancy  of  investment   (See 
"Investments") 

Accountants,  duties  of,  on  dissolu- 
tion of  partnership,  23 

Accounting 

accrual  basis  of,  300,  301 
cash  basis  of,  299 
principles   of,   as   to  net  assets 
and  net  income,  300 

Accounting  systems 
double  entry,  69-79 
logismography,  80-82 
single  entry,  54-68 
statmography,  82-83 

Accounting  theories 

concerning  fiduciaries,  491 
of  bond  issues,  338,  339 
of  depreciation,  439 
preliminary  studies,  19 
relation  to  business  law,  19 

Account,  proprietor's 
assets  and  liabilties  in,  63,  64 
debits  and  credits  in,  64-66 
in  single-entry  ledger,  59,  60 
in  single-entry  system,  54-68 
with  bills  payable,  61,  65 
with  cash,  60,  61,  66 
with  creditors,  60,  62,  65 
with  customers,  60,  62,  65 
with  merchandise,  62,  64 

Account,   realization  and  liquida- 
tion, 475-490 
Peter  Post  problem,  481-490 
preparation  of,  476-490 
principles  involved  in,  480 

Accounts 

asset,  134-137 


cash  (See  "Cash  Account") 

classification  of,  131,  134 

clearing  of  mixed,  312-314 

controlling,  124-130 

creditors',  57,  60,  62,  65 

customers',  55,  56,  60,  62,  65 

drawing,  381-383 

economic,  132 

fictitious,  132 

liability,  134,  135,  137,  138 

loans  payable,  382 

loss  and  gain,  132 

meaning  of  ledger,  121,  122 

nominal,  132 

nominal  in  double  entry,  73 

of  fiduciaries,  491-501 

partly  real,  partly  nominal,  133, 
308 

payable,  354,  355 

personal  and  impersonal,  131 

proprietorship,  380-383 

real,  131 

representative,  133 

sundry,   122 

unapplied  profits,  382 

undivided  profits,  382 

with  bond  premiums  and  dis- 
counts, 341,  342,  344 

with  bonds,  269,  270 

with  discounts  on  capital  stock, 

332,  333 
with  donated  stock,  334 
with  goods   (See  "Merchandise 

Account") 
with  partnership  before  referee, 

23 
with  premiums  on  capital  stock, 

232,  333 


503 


504 


INDEX 


Accounts,  corporate 

capital  stock  balance,  48 

subscriptions,  46 
form,  45 

with  stock,  48-52 
forms,  50,  SI,  53 
Accounts  payable 

audited  vouchers,  355 

components  of,  354 

dividends  declared,  355,  356 

in  balance  sheet,  354 

in  general  ledger,  354,  355 

profits  undistributed,  357 

records  of,  354 
Accounts  receivable 

in  general  ledger,  156 

items  comprised  in,  157 
Accrual  basis  of  accounting,  300, 

301 
Accrued  liabilities    (See  "Liabili- 
ties") 
Additions  defined,  228 
Advertising 

apportioning  cost  of,  310 

left-over  material  for,  312 

unexpired  contracts  for,  310, 311 
American   Association   of    Public 
Accountants,  definition  of  as- 
sets, 135 
Amortization 

accuracy  of  methods  of,  273,  277 

data  required  for,  280 

illustrative  examples  of,  274, 276, 
278,  279,  282 

method  of,  281-283 

of    bond    premiums    and    dis- 
counts, 273,  275 

of  part  of  cost,  272 

views  of  courts  on,  279 
Assessments    against    real    estate, 

286,  287,  364 
Assets 

accounting  definition  of,  136 

accounts  with,  134,  135,  137 

copyrights,  255 


definitions  of,  135,  136 

dividends,  301 

good-will,  247 

loans  on  collateral,  268 

nature  of  physical,  377 

notes  as,  161 

of  concerns  about  to  liquidate, 
136 

of  going  concerns,  136 

of  partnership  at  dissolution,  21 

on  accrual  basis,  300 

patents,  251 

problem  in,  390 

proof  of  ledger,  389,  392 

trade-marks,  254 
Assets  and  liabilities 

statement  of,  in  single  entry,  67 
Auditor  of  corporation,  43 

B 
Balance  sheet,  396-429,  447-460 
accounts  payable  in,  354 
arrangement  of  assets  and  lia- 
bilities, 406-417 
consolidated,  447-460 
developed  into  ledger,  405 
double  form  of,  410-412 
English  arrangement  of,  406 
form  for  banks,  418-421 
form    for   life    insurance   com- 
panies, 421-423 
form  for  steam  roads,  424-428 
of  assets  and  liabilities,  394 
order  of  items  in,  407 
problem  in  finding,  386 
reading  of,  416,  417 
usual  form  of,  408 
variant  forms  of,  409,  413 
working  form  of,  396-397 
Balance  sheet,  consolidated,  447-460 
comment  on  problem  in  forma- 
tion, 457-460 
elements  of,  447 
elimination  of  items  in,  459 


INDEX 


505 


Balance  sheet,  consolidated — coti" 
tinned 

formation  of,  453-456 

form  of,  449-452 

problem  in  making,  449,  450 

purpose  of,  447 
Bank  ledger,  ill 

Bankruptcy  Act,  on  partnerships,  23 
Banks 

balance  sheet  for,  418-421 

view  on  capital  and  surplus,  30 
Betterments  defined,  228 
Bills  of  exchange  (See  also  "Ac- 
counts" and  "Bills  Payable"), 
351,  352 

definitions  of,  163,  164 

relations  created,  164 

relation  to  bills  receivable,  163, 
164 
Bills  payable 

accounts  with,  61,  65 

journal  entry  for,  351 

memorandum  checks,  352 

parties  to,  351,  352 

postdated  checks,  351 
Bills  receivable,  163 
Bonds,  336-345 

accounting    theories   of    issued, 
338,  339 

accounts  with,  269,  270 

acquired    by    issuing    company, 
339-342 

as  investments,  270 

as  trust  funds,  280 

characteristics  of,  34 

collateral  trust,  35 

consolidated,  38 

convertible,  38 

coupon,  38 

debenture,  35,  37 

discounts  on  sales  of,  341,  342 

divisional,  36,  37 

equipment,  35 

floated  by  stock  issue,  33 

income,  37 


income  from,  305 

interest  on,  38,  271 

investment  accounting  with,  273- 

283 
issues  of,  337 

kinds  and  classes  of,  34-38,  337 
land  grant,  36 
liability  for,  339 
mortgage,  36,  37 
partly  secured,  37 
premiums  on  sales  of,  341,  342 
real  estate,  36 
redeemable,  37 
refunding,  38 
requirements  of  state  law  as  to, 

34 

secured,  35,  36 

security  for  loan,  263 

terminal,  36 

unsecured,  37 
Bonus,  stock  as,  33 
Bookkeeping,  definition  of,  121 
Book  values,  adjustment  to  mar- 
ket value,  284 
Boston  ledger  (See  "Ledger") 
Buildings 

account  with,  223-226 

additions  defined,  228 

betterments  defined,  228 

construction  costs,  225 

distinct  from  land,  221 

expenditures  on,  226-228 

increased  valuation  of,  229 

labor  and  expenditures  on,  225 

original  cost  of,  224 

renewals  defined,  228 

repairs  defined,  229 

replacements  defined,  229 
By-laws,  corporate,  39.  40 


Capital 
distinguished  from  capital  stock, 

29 
in  limited  partnership,  21 


5o6 


INDEX 


Capital — continued 

of  corporations,  29 

of  partners,  382 

relation  to  profits  and  surplus, 
30 
Capital    expenditures    (See    "Ex- 
penditures") 
Capital  stock  (See  "Stock") 
Cash 

accounts   with,   in   single  entry, 
60,  61,  66,  67 

disbursements,  61 

journal  transactions  in,  86,  87 

receipts  from  sales,  60,  61 

treasurer's   memoranda   of,    144 
form,  148 
Cash  account 

examples  of,  140,  141 

forms,  146-148,  150 

in  single  entry,  66,  67 

petty,  145 

proper  operation  of,  143-145 

relation  to  cash  balance,  142 

theory  of,  139 

with  receipts  and  disbursements, 

139 
Cash  basis  of  accounting,  299 
Cash  book  (journal) 

debits  and  credits  in,  87 

developed  into  journal,  96 

forms,  97,  98,  100 

illustrative  entries  in,  93,  94 

petty,  99 

primitive  form  of,  93 
Cash  discounts,  438 
Cash  journal  (See  "Cash  Book") 
Certificates,  stock 

binds  stockholders,  31 

issue  of,  not  essential,  31 
Check  registers  (See  "Registers") 
Checks 

acceptance  of,  351 

canceled,  143,  147 

form  of  register,  147 

memorandum,  352 


postdated,  351 

register  of,  143,  144 
Claims,  against  partnerships,  25 
Collateral 

accounts  with,  270 
form,  269 

loans  secured  by,  268 
Commission 

accounting  for,  195,  204 
form,  218 

defined,   186 

"del  credere"  agreement,  187 

journal  entries  for,  197,  199,  206 

record  of,  192 
Commission  merchant  (See  "Con- 
signees") 
Common  stock,  30,  360 

defined,  30 

par  value  of,  29 
Conditional  sales  (See  "Sales") 
Consignees 

accounts  of,  189-192 

advances  made  by,  188 

books    for   separate   agency  ac- 
counts, 200 

books  of,  190-192 

classes  of,  186 

closing  entries  on  books  of,  196, 
197 

commissions,  advances  and  ex- 
penses, how  determined,  194 

duties  and  liabilities  of,  187-192 

expenses  of,  188 

instructions     from     consignors, 
187-188 

liens  of,  for  expenses,  188 

may  accept  notes  in  settlement, 
188 

may  not  refuse  draft  on  notice, 
189 

not  chargeable  with  interest  on 
deferred  statement,  189 

occasional,  187 

prerogatives  of,   in  absence  of 
instructions,  187 


INDEX 


507 


Consignees — continued 

relations  with  consignors,  186 
separate  agency  accounts  of,  200 
state  requirements  as  to  bonds 

for,  186 
theory  of  occasional,  203 
trial  balance  of,  193,  198 

Consignments     (See    also    "Ship- 
ments") 
acceptance  of,  by  factor,  189 
account  sales  for,  198,  199 
book  records  of,  191,  192 
criticism    of    consignment    ac- 
count theories,  207 
entries  on  receipt  of,  203-205 
entries  on  sales  of,  204-206 
forms.  201,  202,  218 
importance  of  subject,  186 
journal  entries  for,  194-196,  304- 

206 
occasional,  203-207 
shipments  inward,  186-207 
shipments  outward,  208-220 

Consignor 
account  sales  rendered  by  con- 
signee, 198 
accounts    with,    on    consignee's 

books,  191,  192 
relations  with  factor,  190 

Consolidated   balance   sheet    (See 
"Balance  Sheet,  Consolidated") 

Consolidation  of  corporations,  447 

Contingent  liability 
entries  for,  162,  163 
for  promissory  notes,  161,  162 
reserves  for,  370,  373 

Controlled  companies,  448 

Controlling  accounts 
explanation  of,  125 
from    subsidiary    ledgers,    129, 

130 
genesis  of,  125 
illustration  of,  127 
in  self-balancing  ledger,  129 


journal  provision  for,  127 

theory  of,  126 
Copartnership     (See     "Partner- 
ships") 
Copyrights 

as  an  asset,  255,  256 

as  personal  property,  255 

assignable,  256 

capitalized  as  good-will,  256 

definition  of,  255 

duration  of,  255 

how  obtained,  255 

salable,  256 
Corporate     records     (See    "Rec- 
ords") 
Corporations 

board  of  directors,  39 

business,  29 

by-laws  of,  39,  40 

capital  liability  of,  321,  323 

capital  of,  29 

classes  of,  29 

debts  of,  33 

defined,  28 

financial,  29,  135 

in  Austria-Hungary,  317 

in  Germany,  318 

officers  of,  42,  43 

organization    and    management 

of,  39-43 
organization   expenses   of,   316- 

318 
power  to  acquire  property,  32 
public  service,  29,  36 
records  of  (See  also  "Records"), 

44-53 
restrictions  on,  20 
stock  and  non-stock,  28 
stockholders  of,  41 
Cost 
book  increase  of,  440 
interest  an  element  of,  439 
of  bonds,  defined,  272 
of  goods,  438 
of  labor,  174,  17S 


5o8 


INDEX 


Cost — continued 

of  manufacturing  concerns,  173- 
176 

of  raw  materials,  174 

overhead,  175,  182-185 

pre-process,  173 

relation  to  income,  272 
Cost  sheet,  180 
Credits,  deferred 

cash  receipts,  366,  367 

defined,  366 

discounts,  366 

hospital  fund,  368 

Interstate    Commerce    Commis- 
sion on,  367,  368 

items  of,  366,  367 

operating  reserves,  367,  368 

premiums,  366 

unearned  fees,  366,  367 
Customers'  accounts,  154-157 

composition  of,  154 

debits  and  credits  in,  154 

deductions  in,  154 

discounts  in,  155 

policy  as  to  charges,  156 

record  of  sales  in,  154 

refunds  in,  154 

returned  sales  in,  154 

D 

Debentures 

of  financial  institutions,  35 

of  railroads,  37 
Debits  and  credits,  in  single  entry, 

55-57 
Debits,  deferred 

classification  of,  316 

list  of,  315 

nature  of,  315 

regarded  as  assets,  315 
Debt 

bonded,    336-345     (See    also 
"Bonds") 

defined,  336 

evidence  of,  336 


kinds  of  funded,  336 

mortgage,  346-350 

of  corporation,  33 

of  decedent,  493 

unsecured,  350-353 
Defeasance,  in  mortgage  contract, 

267 
Deferred    debit    items     ( See 

"Debits") 
Deferred  credits  (See  "Credits") 
Deficiency  account,  471-473 
Del  credere  agreement,  187 
Depreciation 

of  machinery,  241,  242,  295,  372 

provision  for,  378-380 

reserves  for,  371-373 
Directors,  board  of 

courts  of  equity  and,  41 

election  of,  39,  40 

fiduciary  character  of,  41 

may  declare  stock  subscriptions 
forfeited,  32 

rights  and  powers  of,  40,  41 
Disbursements 

application  of  word,  389 

in  single  entry,  60,  61 

of  assets,  389,  393,  395 

of  cash,  389 
Discounts 

bond,   in   interest  account,  342, 

343 
cash,  438 

deductions  for,  155 
entries  for,  155 
journal  entries  for,  169 
ledger  account  with,  156 
on  bond  sales,  341,  342 
relation  to  merchandise  account, 

167 
trade,  definition  of,  155 
Dividends 
accounting  treatment  of,  362 
as  asset  and  income,  301 
as  corporation  debts,  30 
defined,  30 


INDEX 


509 


Dividends — continued 
from  invested  values,  359-361 

from  profits,  359-361 

on  mining  stock,  284 

stock,  361 
Donation  account,  334 
Double-entry  system 

a  balancing  system,  69-71 

distinguished  from  single  entry, 
75 

nature  of  journal,  75 

nominal  accounts  in,  73 

origin  of,  59 

passing   to,    from   single   entry, 
76-79 

principles  of,  69,  70 

profit  and  loss  in,  73 

purpose  of,  69 

rules  for,  74 

rules  for  journalizing,  71-73 
Drawing  accounts,  381-383 


Earnings  on  investments,  301-305 

records  of,  302-305 
Equations  in  single  entry,  58 
Equilibrium 

how  established,  129 

in  double  entry,  71,  74 

in  single  entry,  68 
Equipment 

book  value  of,  235 

delivery,  235 

general,  237 

horse,  wagon  and  harness,  235 

replacements   and   additions   to, 
235 
Equity  of  sole  proprietor,  381 
Excise  taxes,  365 
Executor 

accounting  of,  493,  494 

accounts  of,   forms  and  sched- 
ules, 496,  501 

compensation  of,  495,  496 


Expenditures      (See     also     "Ex- 
penses") 

capital,  226,  227,  444 
Public     Service     Commission 
on,  228,  229 

revenue,  226,  227 
Expense  distribution 

labor  and  material  rate,  183 

labor  basis,  182,  183 

machine  rate  basis,  183,  184 

material  rate,  183 

pay  rate,  183 
Expenses 

allocation  of  periodical,  307 

legal,  260 

organization,  316-318 


Factor  (See  "Consignees") 
Fees 

defined,  364 

for  licenses,  364 
Fiduciaries,  accounts  of,  491-501 

courses  of  instruction  in,  491 

differentiation  of  principal  and 
income,  491,  501 

executor's    accounts,    493,    494, 
496,  501 

payment  of  debts  and  legacies, 

495 
statutory    provisions    for,    491, 

492,  495 
the  inventory,  492,  493 
Financial  statements  (See  "State- 
ments") 
Fire  insurance  (See  "Insurance") 
Fixtures 
court  decisions  on,  233 
law  of,  232,  233 
personalty,  231 

realty    and    personalty    distin- 
guished, 233,  234 
realty  defined,  231 
Forfeiture  of  stock  subscriptions, 
32 


5IO 


INDEX 


Franchises 

characteristics  of,  258 

debits  to,  258,  259 

definition  of,  256 

of   public   service   corporations, 
259,  260 

primary,  257 

secondary,  257 

state  and  municipal,  258 
Funded  debt  (See  "Bonds") 
Funded  reserves,  293 
Funds,  specific 

kinds  of,  292 

purpose  of,  292 

reserves,  293-295 

sinking  funds,  296-299 
Furniture    (See  also  "Fixtures") 

definition  of,  234 


General  ledger,  116,  117,  124  (See 
also  "Ledger") 

Goods 
in  finished  stage,  175 
in  process,  174 
inventories  of,  176-182 
forms,  178,  180 

Good-will 
an  intangible  asset,  244 
as  an  asset,  247 
component  parts,  458 
creation  of,  249,  250 
depreciation  of,  248,  249 
of  controlled  company,  457 
of  corporations,  245,  246 
of  sole  proprietorships,  245 
personal  character  of,  244 
sale  of,  247 
treatment  of  in  consolidations, 

246 
value  of  in  partnership,  26 


H 


Holding  company 
components  of,  448 


problem    in    incorporating,   449- 

460 
purpose  of,  447 

I 

Imprest  fund 

book  for,  99 

forms,  100 

how  maintained,  151 

journal  entry  for,  152 

origin  of,  152 

theory  of,  152 
Income 

accrual  basis  of,  300 

accruals  of,  39s 

accrued,  not  due,  299-306 

distributing  debits  to,  405 

dividends  as,  301 

from  bonds,  305 

from  investments,  299 

in  financial  statements,  430-438 

on   bond   investments,   272,   273 

only  cash  considered,  299 

relation  to  cost,  272 
Incumbrances 

liability  for,  287 

on  real  estate,  286,  288 
Industrial  enterprises,  capital  ex- 
penditures for,  227,  228 
Inheritance  tax,  366 
Insurance,  fire 

account  with,  308 

premiums  on,  309,  310 

refund  of  premiums,  309 

Union  short  rate  tables,  310 
Interest 

accrued  on  investments,  305 

as  affecting  cost  of  investment, 
271 

as  an  element  of  cost,  439 

bond    premiums    and    discounts 
as,  342,  343 

entries  for  accrued,  304,  305 

on  bonds  purchased  for  invest- 
ment, 270,  271 
on  mortgages,  265 


INDEX 


511 


Interstate  Commerce  Commission 

balance   sheet    form    for    steam 
roads,  424-428 

on  "Capital    Stock    Liabilities," 
329 

on  "Deferred  Debits,"  315 

on  "Organization  Expenses,"  317 

on  "Reserves,"  293,  295 

ruling   as    to    income   and   sur- 
plus, 444 

ruling  on  asset  terminology,  413 

ruling  on  balance  sheet,  368 

ruling  on  capital  stock  deferred 
credits,  367 

ruling  on  capital  stock  deferred 
debits,  317 

ruling    on     capital     stock     dis- 
counts, 332 

ruling    on    capital    stock   prem- 
iums, 331 
Inventories 

of  merchandise,  171 
form,  180 
Investments,  261-291 

accountancy  of,  280 

in  bonds  of  other  companies,  269 

income  from,  299-301 

in  real  estate,  285-291 
form  (ledger),  290 

in    stocks    of    other    companies, 
283-285 

interest  purchased,  271 

mortgages  as,  264 

of  available  funds,  261 

of  surplus  capital,  261 

permanent,  263 

policy  of  carrying,  289,  291 

securities  as,  262,  263 

speculative,  261,  262 

temporary,  262 


Journal,  84-109 

adjusting  entries   for  trial  bal- 
ance, 400 


cash  (See  "Cash  Book") 

development  of  journal  system, 
85 

entries  for  capital  stock,  324, 
325 

entries  for  earnings  on  invest- 
ments, 302-305 

example  of  single  entry,  78,  79 

forms,  91,  92,  95-98,  100-102, 
105-108 

in  double  entry,  71,  74,  75 

in  single  entry,  75 

origin  of,  84 

provides  for  controlling  ac- 
counts, 127 

purchase  (See  "Purchase  Jour- 
nal") 

sales  (See  "Sales  Journal") 

segregation  of  accounts,  86-90 

specially  ruled,  108,  109 

sub-journals,  85-90 


Labor  rates,  182 

Land  and  buildings,  221-230 

improvements  on  land,  222 

investments  in  land,  223 

land   distinguished   from  build- 
ings, 221 

plant  land,  221,  222 
Ledger,  1 10-130 

accounts  on  accrual  basis,  303 

accounts  with  capital  stock,  323- 
328 

"Bank,"  in 

"Boston,"  III,  114-116 
form,  112-114 

card  form,  118 

character  of,  no,  in 

definition  of,  124 

form  of  account,  ni 

general,  116,  117,  124 

loose-leaf  form,  118 

private,  116,  117,  130 

reconstruction  of,  125 


512 


INDEX 


Ledger — continued 

relation  to  private  ledger,  117 

relation   to    subsidiary    ledgers, 
130 

self-balancing  form  of,  129 

stock  subscription,  46 
form  of,  45 

structure  of,  no 

subsidiary,  124,  125,  129,  130,  267 

technique  of  posting,  121-123 

variant  forms,  in,  118 

voucher  record  as  a,  118,  119 
Ledger,  private 

as  controlling  general  ledger,  130 

functions,  116 

relation  to  general  ledger,  117 
Ledgers,  subsidiary 

accountants'  views  of,  130 

effect  of  keeping,  129 

for  secured  loans,  form,  267 

posting  to,  126 

purpose  of,  124 

relation  to  general  ledger,  124, 
128 
Legacies,  495 
Legal  expenses,  260 
Liabilities 

accounts  with,  134,  135,  137,  138 

and  "accountabilities,"  320 

definitions  of,  137 

different  forms  of,  137,  138 

for  bond  issue,  339 

of  concerns  about  to  liquidate, 
138 

of  corporations,  29,  134 

of  general  partner,  21 

of  going  concerns,  137 

of  limited  partner,  21 

of  stockholders,  31,  33,  41 
Liabilities  accrued 

assessments,  364 

components  of,  363 

license  fees,  364 

taxes,  363-366 

when  recorded,  363 


Licenses,  364 
Liens 

against  partnership  assets,  26 

on  real  estate,  286 
Life  insurance  companies,  balance 

sheet  for,  421-423 
Life-tenants,  279,  280 
Liquidation    account     (See    "Ac- 
count") 
Liquidation,  voluntary 

closing  books  in,  474 

closing  proprietors'  accounts  in, 

474 

copartnership,  474 

corporation,  474 

treatment  of  surplus,  475 
Loans 

call,  268 

on  bond  and  mortgage,  263,  264 

repayment  of,  268 

secured,  266-269 
form,  267 

secured  by  collateral,  268 

securities  pledged  for,  268 

time,  268 
Logismography,  62,  80-82 
Losses  from  operations,  430 

M 
Machine  rate,  183 
Machinery  (See  also  "Tools") 

accounts  for,  239 

definition  of,  238 

depreciation  of,-  241,  242 

distinguished  from  tools,  239 

special,  240,  241 

universal,  240 
Manufacturing  concerns 

apportionment  of  overhead,  182- 
185 

cost  sheet  form,  180 

finished  goods,  accounts  of,  175 

finished   goods,   inventories   of, 

179 
general  factory  overhead,  175 


INDEX 


513 


Manufacturing  concern  s — con- 
tinued 

goods  in  process,  accounts  of, 
174 

goods  in  process,  inventories  of, 
179 

inventory  of,  without  cost  sys- 
tem, 179 

manufacturing  burden  of,  174 

manufacturing    stages    in,    173, 

174 
merchandise    accounts    of,    173- 

177 
merchandise  inventories  of,  176, 

177 
raw  materials,  accounts  of,  173 
raw  materials  and  supplies,  in- 
ventories of,  177 
unproductive  labor,  accounts  of, 
174 
Margin  on  loans,  268,  269 
Material  rate,  183 
Merchandise  accounts 
analysis  of,  168 
debits  and  credits  in,  165-167 
discounts  in,  167 
freight  and  cartage  in,  167 
in  single  entry,  62,  64,  67 
inventories  in,  171 
journal  entries  in,  169,  170 
of  manufacturing  concerns,  173- 

185 
of  trading  concerns,  165-167 
on  cash  basis,  300 
purpose  of,  166 

relation  to  profit  and  loss,   170 
removal  from  journal,  86 
returned  sales  in,  166 
stock  ledger  for,  171 

form,  172 
subdivision  of,  168-170 
Merchandise  stock  book,  171,  172 
Mines,  380 
Minute  book,  44,  46 


Mortgages 
accounting   procedure    for,   265, 

266 
as  collateral  contracts,  264 
as  permanent  investments,  264, 

265 
as  security  for  bonds,  337 
as  security  for  loan,  266-268 
chattel,  348,  349 
considerations  for,  346-348 
definition  of,  264,  267 
foreclosure  of,  264 
interest  on,  265,  349 
Louisiana  law,  346 
mortgagee's  rights  under,  264 
real  estate,  346 
register  of,  265,  266 
validity  of,  346 
Mortgagor,  rights  of,  347 

N 

Negotiable  paper  (See  also  "Notes 
Receivable") 

contingent  liability  for,  161 

of  partnerships,  26 
Nominal  accounts,  132 
Non-stock  corporations,  28 
Notes  and  bills  journal 

character  of,  99,  103,  104 

entries  in,  103,  104 

forms,  loi,  102 

value  of,  103 
Notes  payable,  350,  352 
Notes,  promissory,  61,  350,  352 
Notes  receivable,  158-164 

contingent     liability     for     dis- 
counted, 159,  160 

dishonored,  161,  162 

effect  on  customer's  status,  158, 

159 
entries  for,  103,  104 
entries  for  dishonored,  162,  163 
entries  to  maintain  equilibrium, 

160 
in  general  ledger,  159 


"514 


INDEX 


Notes  receivable — continued 
journal  for,  99,  103 
to  what  applied,  164 
treatment  of,  in  accounts,  158- 
161 

O 

Obsolescence 

depreciation  for,  372 

of  machines,  241,  372 
Officers,  corporate 

auditor,  43  • 

president,  42 

secretary,  42 

treasurer,  42 

vice-president,  42 
Operating  reserves,  367,  368,  370 
Operations 

losses  in,  430 

profits  in,  430 
Organization  expenses,  316-318 
Overhead  expenses 

added  to  cost  of   construction, 
225 

apportionment  of,  182-185 

components  of,  439 

labor  rate  basis,  182 

machine  rate  basis,  183 

material  basis,  183 


Par 

in  bond  accounts,  270 
of  stock,  29 
relation  to  cost,  272 
Partners 
advances  by,  24 
claims  against  partnership,  25 
continuing,  27 
contributions  of,  23,  24 
credits  of,  undrawn,  25 
debts  incurred  by,  24 
dormant,  21 

duties  as  to  accounts,  25 
general,  20 


mcommg,  27 

limited,  21 

litigation  between,  23 

nominal,  22 

retiring,  26 

rights  of  surviving,  26 

special,  21 

status  of  retiring,  26 
Partnerships 

account  with,  before  referee,  23 

articles  of,  22 

Bankruptcy  Act,  23 

capital  accounts  of,  383 

capital  liability  of,  321 

claims  against,  25 

classes  of,  20 

debts  of,  25 

defined,  20 

effect  of  oral  agreements,  24 

general,  20,  22 

good-will  of,  26 

how  regarded  by  courts,  23 

incoming  partners,  27 

interest  on  advances,  25 

limited,  20,  22 

liquidating  accounts  of,  425 

negotiable  paper  of,  26 

obligations  of,  26,  27 

procedure  of  claims  against,  25 

property  of,  24 

restrictions  on,  20 

termination  of,  22,  23,  25 

unapplied  profits  of,  382 
Patents 

accounting  treatment  of,  251-253 

as  monopolies,  250,  251 

definition  of,  250 

duration  of,  251 

how  written  off,  252 
Patterns 

book  value  of,  236 

definition  of,  236 

how  written  off,  236 

special,  236 


INDEX 


515 


Pay-roll  journal 

forms,  105-107 

function  of,  104 

loose-leaf  form  of,  109 
Peter  Post  problem,  481-490 
Petty  cash 

definition  of,  149 

how  handled,  148,  149,  151 

imprest  fund  plan,  99,   151,  152 

journal  entry  for,  149 

nature  of,  148 
Petty  cash  book 

as  an  independent  record,  148 

forms,  100,  150,  153 

purpose  of,  99 

relation  to  general  cash,  99,  148 
Petty  cashier,  149,  151,  152 
Pledge 

a  form  of  security,  266 

as  security  for  loan,  264,  266,  349 

differs  from  lien,  267,  268 

right  of  holder  to  sell,  267,  268, 
270 

value  of,   compared  with  loan, 
268,  269 
Pledgee,  rights  of,  268,  269 
Posting 

defined,  121 

method  of,  121 

rules  for,  122 
Potential  stock,  29,  325 
Preferred  stock,  30,  360 

defined,  30 

rights  of,  to  surplus,  360 
Premiums 

amortization  of  bond,  273,  275 

bond,   in   interest   account,   342, 

343 
deductions  from  principal,  343- 

345 
fire  insurance,  309 
on  bond  sales,  341,  342 
on  capital  stock,  329-331 

Printing  (See  "Stationery") 

Private  ledger,  116,  117 


Profit  and  loss 
account  with,  in  double  entry,  "jz 
debits  and  credits  to,  430 
discounts  and  premiums  on  bond 

sales  in,  342 
in  single  entry,  66,  68 
in   statement    for   steam   roads, 

443 
statement  of,  430-438 

Profits 
accountants'  view  of,  229 
available  for  dividends,  359-361 
capital  stock  premiums  as,  329- 

331 
from  operations,  430 
of  corporations,  30 
of  partnerships,  382 

Promissory  notes,  61,  350,  352 

Property 
acquired  by  stock  issue,  32 
appraisal  of  corporate,  32 
partnership,  24 
taxable,  365 
taxes  on,  365 

Proprietorship  accounts 
drawing,  381-383 
positive    and    negative    compo- 
nents of,  380,  381,  383 
unapplied  profits,  382 
undivided  profits,  382 

Proprietor,  sole 
drawing  account  of,  381-383 
laws  affecting,  319 
relation   to   assets   of   business, 
320,  321,  380 

Public  Service  Commission 
definition  of  additions,  228 
definition  of  betterments,  228 
definition  of  renewals,  228 
definition  of  repairs,  22y 
definition  of  replacements,  229 
general  powers  of,  429 
ruling  on  balance  sheets,  429 
ruling  on  organization  expenses, 
317 


5i6 


INDEX 


Purchase  journal 

derived    from   original   journal, 
85-88 

forms,  91,  92 

for  "returned"  purchases,  fO 

functions  of,  90 
Purchasing  department 

activities  of,  90 

records  of,  90 

R 

Railroads,  steam 

balance  sheet  for,  424-428 
Real  estate 
accounting   for   investments   in, 

287-291 
components  of  cost  of,  289 
investments  in,  285-291 
Realization     account     (See    "Ac- 
count") 
Receipts,  warehouse,  350 
Records,  corporate 
corporate  journal,  48 

forms,  49,  51 
minute  book,  44,  46 
of  capital  stock,  323-328 
statutory  requirements,  44 
stock  book   (ledger),  48 

forms,  49,  50 
stock  certificate  book,  46 

forms,  46,  47 
stock  transfer  book,  52 

form,  53 
subscription  ledger,  46 
form,  45 
Redemption  fund 

distinct  from  sinking  fund,  298 
for  premium  on  bonds,  277 
Registers  of  checks,  143,  147 

form,  140 
Remaindermen,  279,  280 
Renewals  defined,  228 
Rent,  as  cost  element,  439 
Repairs  defined,  229 
Replacements  defined,  229 


Reserve  funds,  293 
Reserves 

as  assets,  293 

as  deferred  debits,  293 

classes  of,  295 

distinguished  from  surplus,  369 

for    depreciation,    295,    371-373, 
378 

for  exhaustion  of  physical  as- 
sets, 377,  378,  380 

for    redemption    of    debt,    370, 

374,  375 
for    surplus    contingencies,    370, 

373,  374 

funded,  293 

how  created,  293-295 

Interstate    Commerce    Commis- 
sion on,  293,  295 

methods  of  creating,  376,  378 

operating,  367,  368,  370 

secret,  370,  373 


Salaries  of  salesmen,  395 
Sales,  conditional 

of    commission    merchant,    198, 
199 

of  partnerships,  26 
Sales  department 

books  for,  93 

statistics  for,  93 
Sales  journal 

forms,  94,  95 

functions  of,  90,  93 

origin  of,  86-88 
Securities 

accounting  treatment  of,  262 

as    temporary    investments,    262 

collateral,   268,   269 

concurrent,  266 

for  speculative  purposes,  262 

kinds  of,  266 

nature  of,  266 
Self -balancing  ledger,  129 


INDEX 


51; 


Shares 

functions  of,  319,  320 

par  value  of,  29 

purpose  of,  29 
Shipments  inward,  186-207 

accounting    methods    for,    189- 
207 

consignee's    account    illustrated, 
193 

consignee's  trial  balance,  198 

factor's     accounts    and    books, 
189-192,  200 

forms,  201,  202 

journal  entries  for,  194-197 

occasional  consignments,  203 
Shipments  outward,  208-220 

accounting   methods    for,   208 

first  accounting  method,  209-211 

form,  218 

journal    entries    for,    209,    210, 
211-215 

ledger  accounts  with,  216-218 

memorandum  for,  218 

second  accounting  method,  211- 
213 

third    accounting    method,    213- 
220 
Single-entry  system,  54-68 

basic  principles,  54,  55 
•  books  required  in,  67,  68 

cash  disbursements,  61 

cash  receipts,  60,  61 

charge  sales,  60 

closing  accounts  in,  62 

debits  and  credits  in,  55-57 

financial    statements    based    on, 

67,  384-395 
gains  and  losses  in,  58,  59 
journal  in,  75 
ledger  accounts,  55,  57,  62 
profit  and  loss  account  in,  68 
promissory  notes,  61 
proprietor's  account,  56-62 
trial  balance  in,  68 
Sinking  fund  rule,  280 


Sinking  funds 

accounting  theory  of,  298 

as  redemption  fund,  298 

company  bonds  in,  340,  341 

methods   of   creating,   296,   297, 
298 
Sole    proprietorship     (See    "Pro- 
prietor, sole") 
Specific   funds    (See   "Funds") 
Statement  of  affairs,  461-473 

arrangement  of,  473 

asset  side  of,  463,  469 

deficiency  account,  471-473 
arrangement  of,  473 

forms,  464,  465 

liability  side  of,  463,  470 

occasion  for,  461 

preparation  of,  466 

status  of,  461-463 
Statement,  financial 

account  form  of,  441,  442 

based  on  single  entry,  67,  384- 
395 

elements  of,  430-432 

for  interstate  steam  roads,  442- 
445 

mechanism  of,  432-437 

of  assets  and  liabilities,  384 

of  cash   receipts  and  disburse- 
ments, 445,  446 

of  income  and  profit  and  loss, 
386,  430-437 
Stationery  and  printing 

accounts  for,  314 

as  assets,  311,  312 
Statmography,  62,  82,  83 
Stock  book  (ledger),  48 

form  of,  49,  50 
Stock,  capital  (See  also  "Shares") 

as  a  liability,  320 

balance  account  of,  48 

common,  30,  360 

distinguished  from  capital,  29 

forfeiture  of,  32 

in  balance  sheet,  328 


5i8 


INDEX 


Stock,  capital — continued 

increase  of,  33 

issued  as  a  bonus,  33 

issued  for  labor  or  services,  33 

issued  for  property,  32 

of   other   companies    as    invest- 
ments, 283 

potential,  29,  325 

preferred,  30,  360 

premiums  on,  329-331 

records  of,  323-328 

reduction  of,  33 

treasury,  332-334 

unissued,  status  of,  329 
Stock  certificate  book,  46 

forms,  46,  47 
Stock  corporations,  29 
Stockholders 

common-law  rights  of,  41 

liability  of,  31,  33,  41 

voting  rights  of,  30 
Stock  journal,  48 

form,  49,  51 
Stock  transfer  book,  53 

form,  52 
Sub-journals,  85-90 
Subscriptions,  stock 

forms  of,  45 

payments  on,  32 

unconditional,  31 
Subsidiary  ledger,  124,  125 
Supplies 

advertising,  311 

stable,  311,  313 

stationery,  311,  314 
Surplus 

court  ruling  on  distribution  of, 
360 

distinguished  from  reserves,  369 

distribution  of,  360 

in  financial  statement,  433 

of  banks,  30 

of  corporations,  30 


Taxes 

business,  365 

classification  of,  364 

date  of  liability  for,  363 

defined,  364 

excise,  365 

federal,  364 

inheritance,  366 

municipal,  364 

property,  365 

state,  364 

on  real  estate,  286,  287 
Titles  to  real  estate,  286 
Tools  (See  also  "Machinery") 

accounts  for,  239 

distinguished     from     machines, 
238 

machine,  238,  239 

shop  and  hand,  238,  242 
Trade  discounts,  155 
Trade-marks 

court  rulings  on,  253,  254 

definition  of,  253 

infringement  of,  254 

treatment  on  books,  254 

use  of,  253 

value  of,  254 
Transportation  equipment,  235 
Treasurer's  department 

cash  journal  for,  94,  99 

information  required  by,  94 

memorandum  book  of  available 
cash,  144 
form,  148 
Treasury  stock 

accounting  for,  333,  334 

definition  of,  333 

"donation"  account  with,  334 

legal  view  of,  332 
Trial  balance 

classified  form,  396 

defined,  396 

of  consignee,  193,  198 


INDEX 


519 


Trial  balance — continued 
posting    journal    entries    from, 
400 
Trust  funds,  280 

V 

Values    defined,    in    single   entry, 

57 
Voucher  record 
defects  of,  118,  120 
form,  119 
mechanism  of,  ziS 


of  expenses  and  payments,  143 
origin  of,  1 18 
Vouchers 
audited  and  unpaid,  147,  355 
ledger  account  with,  143,  144 

W 

Warehouse  receipts 

as  security,  350 

defined,  350 

negotiable,  350 
Working  balance  sheet,  396-405 


Practical  Problems 

To  Accompany  "The  Applied  Theory  of  Accounts* 


PROBLEM    I 

To  illustrate  the  general  principles  of  corporation  ac-* 
counting,  and  particularly  the  mechanism  of  the  corporatt, 
journal.    (See  Chapters  III,  IV.) 

The  Goldengate  Mining  Company  has  been  incorporated 
to  extract  silver  from  veins  located  in  Mexico.  The  capital 
stock  of  the  company,  which  is  divided  into  30,000  shares 
of  common  stock  of  the  par  value  of  $10  per  share,  is  issued 
March  i,  19 16,  as  follows: 

To  A.  Rosenberger,  Incorporator,  for  cash  @  par,  50  shares,  cert.  No.  1 
"   B.  Rothschild,  "  "      "      "     "    50       "         "       "    2 

"    C.  Silverstein,  "  "      ' 50       "  "       "    3 

"   D.  Gangloff  "  "      "      "     "    50       "         "       "4 

"  John  Skeener,  Vendor,  for  land 

purchased 29,800  shares,  cert's  Nos.  5  to  30a 

On  March  4,  19 16,  John  Skeener  donates  to  the  com- 
pany certificates  numbers  5  to  204,  which  are  to  be  placed 
in  the  treasury,  and  sold  to  acquire  working  capital.  Dur- 
ing March  and  April,  the  following  stock  transactions  occur : 

March  5,  Sold  out  of  treasury  to  John  Doe 1,000  shares  @  $8.50 


"  V.  Roe 500 

March;,      "      "     "         "        "  Y.  Kalisher 400 

"      "    "         "        "  Peter  Henry 5,000 

April    I,      "      "     "         "        "  John  Sidney 700 

April  15,      "      "    "         "        "  Bankers' Union  Inc.  12,400 

20,000 


"  $8.50 
"  $8.60 
"  $8.70 

"  $8.75 
"  $8.80 


C22  PRACTICAL    PROBLEMS 

During  the  same  period,  the  following  transfer  notices 
have  been  received  by  the  company : 

March  12,  Sold  by  John  Doe  to  Henry 

Doe 500  shares,  cert's  Nos.  303-7* 

24,     "       "    Peter   Henry   to   A. 

Arnold  2,000      "  "        "     322-41 

April   20,     "       "Bankers'  Union  to 

Miners'  Bank 6,000      "  "        "     404-63 

Required : 

The  recording  of  the  above  facts  on  the  corporate 
stock  journal  of  the  Goldengate  Mining  Company. 

•New  certificate  numbers  are  to  be  provided  for  the  issue  of  treasury  stock 
and  for  exchanges. 


PROBLEM    II 

To  illustrate  the  principles  of  accounting  involved  in 
recording  the  transactions  incident  to  the  organization  of  a 
corporation,  and  the  mechanism  of  corporate  accounting 
records.    (See  Chapter  IV.) 

At  a  meeting  held  on  January  25,  19 16,  the  incorpora- 
tors of  the  Carlton  Manufacturing  Company  approve  the 
articles  of  incorporation  of  the  company  drawn  by  counsel 
in  accordance  with  the  corporation  laws  of  New  Jersey.  The 
stock  subscription  book  is  signed  by  them  as  follows : 

Name  Shares  Amount 

Paid 

H.R.Pitt 20            25%   (Paid  by  check) 

R.  V.  Carson 20            25%  "  " 

H.St.  John 20            25%  "  " 

S.  Verner 20           25%  "  " 

Y.Lucas 20           25%  "  " 


PRACTICAL    PROBLEMS  523 

The  articles  of  incorporation  are  filed  February  i,  19 16, 
with  the  Secretary  of  State  and  the  county  clerk,  the  in- 
corporators paying  fees  of  $210  for  filing  and  incorporat- 
ing. The  authorized  capital  stock  is  $1,000,000,  divided 
into  shares  of  $100  par  value. 

Between  January  25  and  February  i,  the  incorporators 
obtain  from  four  prominent  financiers,  subscriptions  to  4,000 
shares  of  stock,  each  subscriber  agreeing  to  take  1,000 
shares;  the  condition  of  the  subscription  is  that  25%  shall 
be  paid  in  cash  upon  subscribing,  and  25%  on  the  first  of 
every  month  thereafter,  until  the  stock  is  fully  paid.  At  a 
meeting  of  the  stockholders,  held  February  10,  the  incor- 
porators are  elected  directors.  The  directors  hold  their  first 
meeting  on  February  11,  and  accept  John  Doe's  proposition 
to  sell  to  the  company  a  suitable  factory,  ready  for  opera- 
tion, together  with  the  land  on  which  it  stands,  and  the  ma- 
chinery and  equipment  which  it  contains,  for  the  sum  of 
$690,000. 

The  conditions  of  the  settlement  to  be  made  by  the  com- 
pany are  as  follows : 

John  Doe,  vendor,  is  to  receive : 

1.  Capital  stock,  $490,000. 

2.  Purchase  money  mortgage,  covering  land,  building, 

and  equipment,  present  or  to  be  acquired,  bearing 
interest  at  6%,  payable  semiannually,  the  mort- 
gage dated  February  i,  19 16,  due  February  i, 
1 92 1.  Amount  of  mortgage,  $150,000. 
3-.  Two  promissory  notes  of  $25,000  each,  bearing  in- 
terest at  6%,  and  due,  one,  five  months  after 
February  i,  19 16,  the  other,  seven  months  after 
February  i,  19 16. 

During  the  period  from  February  i  to  May  10,  1916, 
the    Carlton    Manufacturing    Company    has    collected   all 


C24  PRACTICAL    PROBLEMS 

moneys  receivable  on  account  of  subscriptions  to  stock,  and 
on  May  2,  19 16,  has  issued  the  stock  subscribed.  From  the 
stock  still  unissued  975  shares  are  issued  the  same  day 
(May  2),  at  par,  to  H.  B.  Turner,  contractor,  in  settlement 
of  extensions  and  alterations  made  by  him  to  the  factory 
building. 

The  certificates  of  stock  issued  are  as  follows : 

No.  of      No.  of 
Date  Name  Cert.       Shares 

Feb.   II,  1916    John  Doe 1-49  100  (in  each  cert.) 

May    2,1916    H.R.Pitt 90  20 

R.  V.  Carson 91  20 

H.  St.  John 92  20 

S.  Verner 94  20 

Y.  Lucas 93  20 

J.  Smith 50-59  100  (in  each  cert.) 

Wm.  Jones 60-69  100 

James  Brown 70-79  100 

Robert  Decker 80-89  100 

H.  B.  Turner 95-103  100 

"  "    "   104-106  20 

"  "    "   107-109  5 

On  May  10,  John  Archbold,  counsel  for  the  company, 
presents  a  bill  for  legal  services  and  expenses  in  connection 
with  the  organization  of  the  company  for  $2,500,  and  agrees 
to  accept  in  payment  therefor,  25  shares  of  stock  at  par. 
Accordingly,  the  following  stock  certificates  are  issued  to 
him: 

No.   no  20  shares 

"     III  5       " 

Required : 

The  recording  of  the  above  stock  transactions  in  a 
properly  ruled  stock  book.  A  "Capital  Stock  Is- 
sued Controlling  Account"  must  be  kept. 


PRACTICAL    PROBLEMS  525 

PROBLEM   III 

Based  on  single-entry  principles.    (See  Chapter  V.) 

John  Armstrong  is  engaged  in  wholesale  trading. 

His  ledger,  opened  by  a  local  bookkeeper,  is  based  on 
the  single-entry  system,  and,  at  December  31,  19 16,  that 
is  to  say,  at  the  end  of  the  first  year's  business,  discloses  the 
following  facts : 

Due  from  Customers  (as  per  schedule) $   995.00 

Due  to  Creditors  ( "     "  "        ) 1,800.00 

John    Armstrong,    Capital    Account    (unchanged    throughout 
year) 8,000.00 

A  single-entry  journal  and  a  check  book  are  the  only 
other  records  kept  by  John  Armstrong. 

The  physical  inventory  taken  on  December  31,  totals 

$3>450- 

You  are  asked  to  ascertain  the  present  worth  of  the 
business,  and  the  extent  of  the  increase  of  the  proprietor's 
worth  during  the  year. 

After  a  preliminary  examination  of  the  records,  and  a 
consultation  with  the  proprietor,  you  find  the  following  as 
at  December  31,  1916: 

Cash  in  Bank $3,320.oo 

Cash  in  Store 150.00 

Notes  Receivable  (all  transactions  in  December,  1916) 50.00 

Notes  Payable  (all  transactions  in  December,  1916) 2,000.00 

First  Mortgage  on  Real  Estate  and  Building* 2,500.00 

Cost  of  Land  and  Building T  Acquired    prior    to    Jan- f  6,000.00 

Cost  of  Furniture  and  Fixtures.,  luary  i,  1916,  with  a  view-^      91500 
Cost  of  Delivery  Equipment J  of    engaging   in    business.  [     750.oo 

•Given  before  January  i,   1916. 

From  the  foregoing  facts,  prepare : 

A  statement  of  assets  and  liabilities  at  January  i,  19 16, 


526 


PRACTICAL    PROBLEMS 


and  at  December  31,  19 16,  showing  the  net  increase  of 
capital  for  the  year,  as  determined  by  the  asset  and  liability 
method. 


PROBLEM    IV 

Based  on  the  application  of  the  principles  of  double  entry 
to  the  construction  of  ledger  accounts  and  introducing  the 
legal  theory  of  consignments  inimrd.   (See  Chapter  XVII.) 


The  general  balance  sheet  of  Armstrong  &  Campbell  at 
March  31,   1916,  shows: 


Assets 

Liabilities 

Land  and  Building 

$6,000.00 

1st  Mortgage  6%,  1918..  $2,500.00 

Furniture  and  Fixtures.. 

915.00 

Notes  Payable *3,i50.oo 

Transportation    Equip- 

Accounts Payable 17,894.80 

ment  

1,550.00 

Reserve  for  Good-Will. .     1,000.00 

Good- Will 

1,000.00 

John  Armstrong,  Capital  13,415.13 

Merchandise  Inventories 

22,890.00 

A.  Campbell,  Capital 11,599.62 

Cash 

10,95575 

Notes  Receivable 

♦1,750.00 

Accounts  Receivable 

4,200.00 

Freight  and  Expenses  on 

Consignment  No.  I.. . . 

120.60 

Freight  and  Expenses  on 

Consignment  No.  2 

130.00 

Freight  and  Expenses  on 

Consignment  No.  3 

48.20 

$49,55955 

$49,559-55 

*A11  to  run  90  days  from  date  of  issue;  received  or  issued  in  March,    1916. 

In  accordance  with  the  requirements  of  their  articles  of 
copartnership,  Armstrong  &  Campbell  took  a  physical  in- 
ventory on  June  30,  19 16.    It  disclosed,  figured  at  cost,  ex- 


PRACTICAL    PROBLEMS 


527 


elusive  of  freight:  merchandise,  $59,843.04;  consignments 
No.  I,  $1,500;  No.  2,  $1,900;  No.  3,  $51.80. 

In  connection  with  consignments,  the  firm  has  decided 
to  settle  for  sales  to  date  by  checks  drawn  June  30,  1916, 
on  the  banking  house  of  Brown,  Smith  &  Co.,  London, 
with  whom  they  deposited  $12,000  on  June  i,  1916.  Under 
the  terms  of  the  consignments,  10%  is  to  be  allowed  to  the 
consignees,  and  the  consignors  are  to  be  charged  with  all 
expenses  for  freight  and  cartage,  for  allowances  on  defec- 
tive goods,  and  for  trade  discounts.  An  account  sales  is  to 
be  forwarded  with  each  remittance.  All  the  sales  made  by 
Armstrong  &  Campbell  for  the  account  of  the  consignors 
have  been  paid  for  by  customers  at  June  30,  19 16. 

The  inventory  pricing  has  not  taken  into  consideration 
freight  on  goods  received  and  not  sold;  so  far  as  you  can 
ascertain,  said  freight  amounts  to  $377.80. 

The  bookkeeper  submits  the  following  trial  balance  and 
explains  that  he  has  closed  the  consignment  accounts,  as  this 
was  necessary  to  ascertain  the  amount  of  remittances  to  be 
made.  With  this  exception,  the  trial  balance  is  before 
closing : 


Trial  Balance,  June  30,  19 16 


Brown,    Smith    &    Co., 

Notes  Payable 

$30,000.00 

London  

$1,198.01 

Accounts  Payable 

49,701.74 

Land  and  Building 

6,000.00 

1st  Mortgage  Payable. . 

2,500.00 

Furniture  and  Fixtures 

975.00 

Consignment  No.  I 

1,500.00 

Transportation     Equip- 

"              "2 

1,900.00 

ment  

3,150.00 

0  •  •  •  • 

51.80 

Cash  

24,93413 

Interest,  Banks 

7560 

Notes  Receivable 

12,000.00 

Reserve  for  Good- Will 

1,000.00 

Good- Will 

1,000.00 

Commissions  —  Con- 
signed Goods 

Freight    and    Cartage 

1,264.82 

Outward 

310.50 

J.  Armstrong,  Capital . . 

13,41513 

Heat  and  Light 

30.80 

A.  Campbell,  Capital... 

11,599.62 

Stable  Expenses 

350.00 

528 


PRACTICAL    PROBLEMS 

Trial  Balance — Continued 


Salaries — Qerks 500.00 

"           Partners  300.00 

"           Salesmen 900.00 

Sundry  Expense — Store  210.50 
Gommissions  —  Sales- 
men    1,850.70 

Consignment  No.  i 1,500.00 

"               "2 1,900.00 

"     3--..  51-80 

Accounts  Receivable 19,388.84 

Merchandise 35.508.43 

J.    Armstrong  —  Draw- 
ings    450.00 

A.  Campbell — Drawings  500.00 

Total $113,608.71 


Total $113,008.71 


The  transactions  of  the  period  under  review  are  as 
follows: 

Merchandise 

Purchases,  $128,020.26;  sales,  $118,066.85;  freight  in, 
$2,540.71;  allowances  on  defective  sales,  $1,555.11;  allow- 
ances on  defective  purchases,  $1,521.29;  trade  discounts 
from  creditors,  $4,645.93;  trade  discounts,  customers, 
$1,781.70;  sales  returned,  $5,930.90;  purchases  returned, 
$2,725.50;  freight  refunded  on  purchases  returned, 
$250.68. 

Consignment  Debits 

Sales  value  of  goods  consigned  March,  1916:  No,  i, 
$10,100;  No.  2,  $5,000;  No.  3,  $1,000.  Freight,  insurance, 
etc.,  March,  1916:  No.  i,  $120.60;  No.  2,  $130.00;  No.  3, 
$48.20.  Freight  on  sales:  No.  i,  $138.60;  No.  2,  $60.10; 
No.  3,  $40.50.  Allowances  to  customers  for  defective  goods : 
No.  I,  $14.16;  No.  2,  $8.20;  No.  3,  $21.03. 


PRACTICAL    PROBLEMS  529 

Consignment  Credits 

Sales:  No.  i,  $8,600;  No.  2,  $3,100;  No.  3,  $948.20. 
Freight  and  allowances  charged  to  consignors:  No.  i, 
$273.36;  No.  2,  $198.30;  No.  3,  $109.73. 

From  the  foregoing  prepare  ledger  accounts :  Cash,  Ac- 
counts Receivable,  Accounts  Payable,  and  all  the 
ledger  accounts  affected  by  the  consignment  transac- 
tion. 


PROBLEM   V 

To  illustrate  the  working  of  the  theory  of  agents'  ac- 
counts as  indicated  by  the  requirements  of  the  law  of  agency. 
Adapted  from  the  New  York  C.  P.  A.  Examination  of 
January,  IP13.*   (See  Chapter  XVII.) 

Karl  Smith  is  a  real  estate  broker  and  agent  who,  among 
other  things,  manages  properties  in  consideration  of  com- 
missions, ranging  from  3%  to  5%  on  rent  collections.  For 
the  last  two  years  his  books  have  been  kept  in  haphazard 
fashion  and  in  violation  of  the  law  of  agency.  They  are 
incomplete  as  to  footings  and  postings;  no  trial  balance  of 
the  general  ledger  has  been  obtained  and  no  reconciliation 
of  bank  balances  has  been  established  during  the  above 
mentioned  period.  The  tenants  rent  book  is  a  species  of 
"tickler"  in  which  the  current  rent  charges  are  entered  in 
pencil  and  inked  in  when  paid ;  the  names  of  the  tenants  of 
properties  not  leased  are  also  entered  in  pencil  and  erased 
when  tenants  move,  the  new  names  being  entered  in  the 
places  thus  left  vacant. 


•The  requirements  of  this  problem  have  been  changed  to  suit  present  needs; 
of  the  orisrinal  reauirements  beinK  essentially  an  auditing  test. 


one  of  the  original  requirements  being  essentially  an  auditing 


530 


PRACTICAL    PROBLEMS 


Having  accidentally  discovered  irregularities  in  the  ten- 
ants book,  Karl  Smith  has  discharged  his  bookkeeper- 
cashier  and  engaged  an  accountant  to  conduct  an  examina- 
tion of  his  books,  records,  and  accounts,  discover  the  extent 
of  the  shortage,  which  he  fears  is  considerable,  and  instal 
a  new  system  of  accounts. 

After  spending  considerable  time  in  an  attempt  to  place 
the  books  on  an  accounting  basis,  the  accountant  finally 
obtains  the  following  trial  balance  of  the  ledger,  as  of  Sep- 
tember 30,  19 1 6,  instals  a  new  system  which  will  permit  his 
client  to  fulfill  his  accounting  duty  as  an  agent,  and  renders 
a  preliminary  report  accompanied  by  a  statement,  showing 
clearly  the  financial  status  and  the  relations  of  Karl  Smith 
to  his  principals : 

Trial  Balance 


(a) 


(b) 


Cash $350.20 

Petty  Cash 

The  Augusta  Terrace ' 

"    Victoria  Court. . 

"    St.  Quentin  Court 

"    Audubon  Court.. 

"    Evening  Despatch 

"    Morning  News . . 

"    Union  Wall  Paper 
Co 

"    Janitors'  Supplies 

Co 

Insurance  Account.. .  (c) 
KarlSmith,Drawings(d)  16,930.00 

Cash  Shortage (e)       380.00 

Salaries 12,140.00 

Office  Expense 3,130.00 

Furniture     and     Equip- 
ment      4,150.7s 

$40,307.50 


100.00 
215.00 
805.00 
650.00 
270.00 
7500 
3500 

111.20 

45-25 
920.10 


Karl  Smith,  Capital 

Commissions 

Phoenix  Insurance  Co.. 

London  Insurance  Co.. 

The  Frederic  Apart- 
ment  

"  Venetian  Court 
"    Franklin  Castle 

St.  Martin  Hall..., 

Tenants 


(f) 


$4,360.40 

22,510.00 

470.00 
450.10 

2,385.30 
2,500.00 
3,231.00 
2,850.70 

1,550.00 


$40,307.50 


PRACTICAL    PROBLEMS  531 

Notation  by  the  accountant: 

(a)  Remittances  on  account  of  collection  of  October 

rents,  paid  in  advance  upon  signing  lease,  not 
as  yet  credited  to  the  principals.  Settlements 
to  be  made  on  the  29th  of  every  month. 

(b)  Balances  representing  payments  from  March  to 

June,  19 1 6,  for  advertising,  decorating  and 
supplies,  for  the  account  of  managed  prop- 
erties. Paid  bills  cannot  be  found;  no  details 
available ;  itemized  receipted  bills  asked  for  by 
letter;  no  answer  at  September  30,  1916. 

(c)  Premiums  on  fire  insurance  placed  by  agent  for 

account  of  sundry  clients  not  principals. 
Premiums  will  be  paid  to  agent  if  risk  is  ac- 
cepted and  he  will  deduct  commissions  of  from 
5%  to  15%  from  settlement  with  companies. 

(d)  Probably  contains  charges  which  might  properly 

be  capitalized  under  caption  "Furniture  and 
Fixtures"  if  positive  information  were 
available. 

(e)  Entries  made  in  cash  book  by  accountant  for  rent 

collections  appearing  in  monthly  statements  to 
principals,  but  not  appearing  in  cash  book  nor 
in  duplicate  of  bank  deposits  obtained  from 
banks. 

(f)  According  to  the  terms  of  his  employment  the 

agent  must  remit  on  the  fifth  day  in  every 
month. 

Prepare  the  trial  balance  of  the  general  ledger  of  Karl 
Smith  as  corrected  by  the  accountant.  Divide  the  said 
statement  into  two  distinct  parts,  one  showing  what  belongs 
to  the  agent,  the  other  showing  what  belongs  to  the 
principals. 


532 


PRACTICAL    PROBLEMS 
PROBLEM    VI 


To  illustrate  one  of  the  methods  of  passing  from  the 
copartnership  to  corporation,  and  the  recording  of  the  trans- 
actions incident  thereto.    (See  Chapter  XXII.) 

The  Smithers-Jones  Company  is  incorporated  under  the 
laws  of  the  State  of  New  York  to  acquire  and  conduct  the 
business  of  the  firm  of  H.  B.  Smithers  and  T.  Jones.  The 
authorized  capital  stock  of  the  company  is  $800,000,  di- 
vided into  $450,000  of  preferred  stock  and  $350,000  of 
common  stock,  of  the  par  value  of  $100  per  share  for  both 
stocks.  The  preferred  stock  is  entitled  to  receive  a  'j% 
dividend  before  any  dividends  are  paid  to  common  stock; 
but  after  the  latter  has  received  an  equal  dividend,  both 
classes  of  stock  shall  participate  equally  in  the  balance  of 
surplus  declared  as  dividends  to  be  distributed.  The  pre- 
ferred stock  is  preferred  as  to  assets. 

The  following  assets  and  liabilities  of  Smithers  and 
Jones,  acquired  and  assumed  by  the  Smithers-Jones  Com- 
pany, appear  on  the  books  of  the  vendor  at  January  31, 
1917: 


Assets 

Land $50,000.00 

Building 150,000.00 

Transportation     Equip- 
ment    10,000.00 

Furniture  and  Fixtures  5,000.00 

Machinery  and  Tools . .  72,000.00 

Goods  in  Process 68,195.00 

Finished  Goods 51,830.00 

Materials  and  Supplies  22,650.00 

Accounts  Receivable...  114,648.00 

Notes  Receivable 16,000.00 

$560,323.00 


Liabilities 

Mortgage  Payable $32,500.00 

Accounts  Payable . .   110,023.00 

Notes  Payable 16,500.00 

Reserve    for    Deprecia- 
tion   of    Physical 

Property 51,300.00 

Capital  of  Partners 350,000.00 


$560,323.00 


PRACTICAL    PROBLEMS  C33 

The  price  which  the  corporation  has  agreed  to  pay  for 
the  properties  taken  over  is  $500,000,  which  is  to  be  paid 
in  stock  of  the  corporation  to  the  three  partners  of  the 
vendor  firm  in  the  proportion  in  which  they  have  divided 
their  profits  in  the  past,  i.e.,  H.  B.  Smithers,  ^  ;  T.  Jones, 
%;  X.  Vreeland,  yi. 

The  stock  is  issued  on  February  2,  19 17,  and  at  their 
meeting  of  February  15,  1917,  the  directors  of  the  com- 
pany decide  to  carry  the  value  of  the  land  at  $70,000;  the 
building  at  $160,000;  the  transportation  equipment  at 
$13,000;  the  furniture  and  fixtures  at  $7,000;  the  machinery 
and  tools  at  $80,000 ;  these  increases  are  based  on  the  pres- 
ent replacement  value  of  the  properties  affected.  The  re- 
serve for  depreciation  is  to  be  carried  at  a  figure  decreased 
in  the  amount  of  the  increases  of  the  book  value  of  the 
physical  assets  other  than  land. 

The  balance  of  the  purchase  price  is  to  be  set  up  as  good- 
will, to  cover  the  firm's  name  and  the  good-will  it  conveys, 
in  addition  to  trade-marks  and  patents  written  oflf  by  the 
copartnership  in  the  last  five  years  to  the  extent  of  $17,000, 
their  original  value. 

Required : 
Explicit  journal  entries  recording  the  above  facts  on 
the  books  of  the  Smithers- Jones  Company. 


PROBLEM  VII 

To  illustrate  a  second  method  of  passing  from  copartner- 
ship to  corporation,  and  the  recording  of  the  transactions 
incident  thereto  on  the  books  of  the  vendee  and  the  vendor. 
(See  Chapter  XXII.) 


534 


PRACTICAL    PROBLEMS 


The  firm  of  Bowman  &  Turner,  including-  J.  Vermont 
as  a  silent  partner,  decides  to  sell  out  to  the  International 
Novelty  Company,  which  the  partners  have  incorporated 
with  an  authorized  capital  stock  of  $200,000,  divided  into 
700  shares  of  6%  cumulative  non-voting  preferred  stock, 
and  1,300  shares  of  common  voting  stock,  all  of  the  par 
value  of  $100  per  share.  The  preferred  stock  is  preferred 
as  to  assets. 

The  contract  of  sale  refers  only  to  fixed  assets  and  work- 
ing and  trading  assets,  the  copartnership  having  agreed  to 
liquidate  its  current  liabilities.  The  balance  sheet  of  the 
vendor  firm  shows  at  September  30,  1916: 


Cash   $11,254.00 

Accounts  Receivable...  39,616.00 

Notes  Receivable 7,000.00 

Finished  Goods 5,320.00 

Goods  in  Process 20,040.00 

Materials  and  Supplies  25,600.00 

Furniture  and  Fixtures  3,800.00 

Shop  Tools 6,540.00 

Machinery  and  Machine 

Tools 38,700.00 

Land,   Factory,   and 

Equipment 60,000.00 


$217,870.00 


Accounts  Payable $45,635.40 

Notes  Payable 11,000.00 

Wages  Payable 1,234.60 

T.  S.  Bowman 75,000.00 

S.  D.  Turner 45,000.00 

J.Vermont 40,000.00 


$217,870.00 


The  price  agreed  upon  as  between  the  copartnership  and 
the  corporation  is  $194,000,  which  is  subject  to  the  follow- 
ing agreement : 

J.  Vermont,  special  partner,  whose  Investment  has,  in 
the  past,  netted  him  6%  per  annum,  will  receive  6%  non- 
voting preferred  stock;  T.  S.  Bowman  and  S.  D.  Turner 
are  to  have  equality  in  the  management  of  the  corporation. 
The  excess  price  to  be  paid  by  the  corporation  over  the  net 
worth  of  the  assets  transferred  by  the  copartnership  is  to 


PRACTICAL    PROBLEMS  c^c 

be  settled  in  bonds  of  the  denomination  of  $500  each,  due 
1932,  bearing  interest  at  6%,  interest  and  principal  to  be 
secured  by  a  mortgage  on  all  the  property  and  equipment. 
The  general  partners  only  are  to  share  in  the  salable  value 
of  the  good-will. 

Required : 

1.  The  expression,  in  journal  entry  form,  of  such  of 

the  above  facts  as  concern  the  corporation. 

2.  The  journal  entries  necessary  to  close  the  books  of 

the  copartnership. 


PROBLEM   VIII 

To  illustrate  the  effect  of  careless  accounting  upon  the 
hooks  of  corporations  which  have  been  created  for  the  pur- 
chase of  copartnerships.    (See  Chapter  XXII.) 

A  and  B  were  copartners  in  a  newspaper  publishing 
business,  sharing  profits  and  losses  equally.  A  trial  balance 
of  their  general  ledger  at  December  31,  1916,  was  as 
follows : 

Operating  Expenses  (less  earnings) $1,343-89 

A's  Investment  Account   (representing  losses  over 

and  above  capital  contributed) i. 519-79 

B's  Investment  Account    (representing  losses  over 

and  above  capital  contributed) 1,519.78 

A's  Loan  Account $6,839.31 

B's  Loan  Account 110.36 

General   Expenses 281.06 

Accounts  Receivable 2,012.14 

Cash 273.01 

$6,949.67    $6,949-67 


536 


PRACTICAL    PROBLEMS 


A  and  B  agreed  to  sell  to  the  Daily  Star  Publishing 
Company,  a  New  York  corporation,  as  of  January  i,  19 17, 
the  newspaper  published  by  them,  together  with  all  the 
assets  of  their  publishing  business  in  consideration  of  45 
shares,  par  value  $100  each,  of  the  company's  capital  stock 
(total  issue,  $5,(X>o)  and  $500  in  cash,  the  company  to  as- 
sume all  the  outstanding  liabilities  of  the  business  carried 
on  by  A  and  B. 

No  new  books  were  opened  for  the  corporation,  the 
books  of  the  partnership  having  been  retained  as  suitable 
for  the  corporate  body.  No  journal  entries  relating  to  the 
assets  acquired,  liabilities  assumed,  and  capital  stock  issued, 
were  made.  Prior  to  the  establishment  of  the  above  trial 
balance,  the  company  received  a  check  for  $500  from  one 
of  the  incorporators,  in  payment  of  subscribers'  shares, 
which  was  credited  in  error  to  A's  loan  account.  The  pay- 
ment of  $500  in  cash  to  A  and  B  as  part  consideration  of 
the  business  purchased  has  not  been  made.  Amounts  of 
$6,839.31  and  $110.36  due  to  A  and  B,  respectively,  are  to 
be  considered  as  liabilities  of  the  corporation.  The  debit 
balances  in  A's  and  B's  investment  accounts  and  the  operat- 
ing and  general  expenses  shown  above,  were  closed  out  to 
profit  and  loss  on  the  books  of  the  company  in  subsequent 
periods. 

Required : 

1.  The  journal  entries  necessary  to  correct  the  books 

of  the  corporation  in  respect  of  its  capital  stock 
and  other  accounts ;  express  the  facts  in  view  of 
a  possible  lawsuit  involving  your  taking  the 
stand  as  a  witness. 

2.  The  trial  balance  of  the  books  as  adjusted  by  you. 

3.  All  the  ledger  accounts  affected  by  your  adjust- 

ments. 


PRACTICAL    PROBLEMS  537 

PROBLEM   IX 

To  illustrate  the  recording  of  certain  phases  of  corpora- 
tion finance,  and  the  difficulty  of  giving  accounting  expres- 
sion to  careless  resolutions  of  hoards  of  directors.  (See 
Chapter  XXII.) 

Two-thirds  of  the  stockholders  of  the  Precision  Ma- 
chine Company,  incorporated  under  the  laws  of  the  State 
of  New  York,  have  consented  to  an  issue  of  bonds  by  the 
company.  Accordingly,  on  January  5,  1916,  they  pass 
resolutions  authorizing  the  issue,  and  define  the  amount, 
denomination,  interest  rate,  and  terms  of  the  bonds,  as 
follows : 

2CX)  bonds  of  $1,000  each,  dated  January  i,  19 16,  due 
December  31,  1922,  bearing  interest  at  4!/^%,  pay- 
able annually  on  December  31;  amount  of  bonds, 
$200,000. 

200  bonds  of  $500  each,  dated  January  i,  1916,  due 
December  31,  1924,  bearing  interest  at  4^%,  pay- 
able annually  on  December  3 1 ;  amount  of  bonds, 
$100,000. 

200  bonds  of  $500  each,  dated  January  i,  1916,  due 
December  31,  1928,  bearing  interest  at  5%,  payable 
annually  on  December  3 1 ;  amount  otf  bonds, 
$100,000. 

The  bonds  are  secured  by  a  blanket  mortgage  on  the 
land,  factory  buildings,  factory  equipment,  and  materials 
and  supplies,  the  conditions  of  the  indenture  being  such  that, 
as  soon  as  one  of  the  issues  of  bonds  is  retired,  the  share  of 
the  mortgage  securing  it  will  apply  to  the  unretired  issues 
of  January  i,  19 16.  The  indenture  contains  a  clause  relat- 
ing to  the  creation  of  a  sinking  fund  out  of  annual  profits 
for  the  redemption  of  bonds  at  maturity. 


538 


PRACTICAL    PROBLEMS 


In  order  that  the  sinking-  fund  provision  of  the  indenture 
may  be  properly  carried  out,  the  directors  of  the  company, 
at  a  meeting  held  January  8,  191 6,  resolve  that  there  shall 
be  charged  annually  to  profits  as  ascertained  at  December 
31,  an  amount  representing  1/7,  1/9,  and  1/13  of  the  par 
value  of  the  bonds  issued,  less  the  amount  of  interest  earned 
by  the  sinking  fund  during  the  prior  period ;  that  an  amount 
of  cash  equal  to  the  amount  of  the  reserve  shall  be  set  aside 
annually,  and  deposited  with  a  trust  company  at  interest; 
that  the  interest  earned  by  the  fund  shall  be  deposited  with 
the  fund  and  credited  to  revenue.  The  board  denies  itself 
the  right  to  use  the  sinking  fund  for  any  purposes  other 
than  that  for  which  it  is  created. 

The  board,  at  the  same  meeting,  resolves  that  the  dis- 
count and  premiums  which  may  be  lost  or  gained  on  the 
sales  of  bonds  shall  be  amortized  in  equal  yearly  amounts, 
throughout  the  life  of  the  bonds. 

The  bonds  were  sold  during  January,  19 16,  as  fol- 
lows: 

Issue  of  4H%  bonds  due  1922,  sold  at  99 
"       "    4^%       "         "     1924,      "      "    par 
"       "    5%  "         "     1928,      "      "    103 

The  trust  company  with  which  the  sinking  fund  is  to 
be  deposited,  has  agreed  to  pay  thereon  4%  interest 
annually. 

Required : 

1.  The  cash  book  entries  for  the  two  years  ended  De- 

cember 31,  19 16,  and  December  31,  191 7, 
giving  expression  to  the  facts  recited  by  the 
problem. 

2.  The  journal  entries,  for  the  same  period,  affecting 

the  sinking  fund  provision  of  the  indenture,  and 
the  amortization. 


PRACTICAL    PROBLEMS  c^g 

PROBLEM   X 


From  New  York  C.  P.  A.  Examination  of  January, 
ipr4*    (See  Chapter  XXIII.) 

An  investment  bond  house  purchases  lo  New  Jersey 
Traction  Company  first  mortgage  5%  bonds  at  83)^;  10 
New  Orleans  Gas  Light  and  Power  Company  first  mort- 
gage 5%  bonds  at  104  (accrued  interest  is  not  to  be 
considered). 

Prepare  the  necessary  entries  to  record  properly  these 
transactions  on  the  books  of  the  bond  house. 


PROBLEM   XI 

From  New  York  C.  P.  A.  Examination  of  January, 
1914.    (See  Chapter  XXIV.) 

A  trust  company  assumes  the  responsibility  of  a  sinking 
fund  on  which  it  guarantees  to  pay  3%  interest.  The 
trustee  receives  $103,000  deposited  to  the  credit  of  the  sink- 
ing fund,  and  on  January  i,  191 1,  invests  on  a  3%  basis  in 
100  Clair  County  Light,  Heat  &  Power  Company  5% 
$1,000  first  mortgage  gold  bonds,  due  July  i,  19 12,  interest 
payable  semiannually. 

Prepare  the  accounts  of  the  trust  company,  showing 
the  invested  amount  and  the  amortization  of  the  premiums 
at  the  several  interest  periods. 


•Auditing  requirements  left  out. 


540 


PRACTICAL    PROBLEMS 

PROBLEM   XII 


Showing  the  effect  which  the  ignorance  of  the  theory  of 
accounts  has  upon  accounting  results.  Adapted  from  prac- 
tical problem  in  New  York  C.  P.  A.  Examination  of 
June,  ipi2.    (See  Chapter  XXV.) 

The  books  of  Vincent  Armstrong  at  June  30,  19 16, 
show  the  following : 


Debits 

Cash  $9,800.00 

Real  Estate 3,000.00 

Office  Furniture 1,095.00 

Investments,  Stocks 7,650.00 

"            Bonds  2,300.00 

"            Margin  Ac- 
count . . .  12,000.00 

Receivable  Accounts 16,000.00 

Expense  Account (f)  9,700.00 

Interest (g)  1,085.30 


$62,630.30 


Credits 
Brooklyn  Terminal  Co., 

(a)  $3,000.00 

Contracts  1-2-3 (b)   11,850.00 

L.  V.  Tramways  Co...(c)  1,640.00 
Consulting  Earnings. .. .  1,980.00 
Report  Earnings. ...  (d)  15,000.00 
A.B.C.  Stock  Brokers...  10,310.00 
Stocks  and  Bonds...  (e)  2,600.00 
Capital   16,250.30 


$62,630.30 


The  books  were  kept  from  June  30,  191 5,  to  June  30, 
191 6,  by  three  different  bookkeepers,  and  an  audit  discloses : 

(a)  The  account  "Brooklyn  Terminal  Company"  con- 
tains receipts  of  consulting  fees  during  the  first  six  months 
of  19 1 6.  This  is  a  monthly  contract  involving  no  expense 
whatever  to  V.  Armstrong. 

(b)  "Contracts  1-2-3"  ^^^  contracts  for  reports  on  the 
engineering  possibilities  of  certain  properties.  The  reports 
have  been  rendered  and  the  expenses  incident  thereto  have 
been  credited  to  expense  and  debited  to  the  amount  received 
under  the  contracts. 

(c)  "L.  V.  Tramways  Company"  represents  $2,coo  re- 
ceived on  May  i,  19 16  (less  expenses)  on  account  of  a  con- 


PRACTICAL    PROBLEMS 


541 


tract  according  to  the  terms  of  which  Armstrong  is  to  act 
as  consulting  engineer  for  10  months  from  May  i  and  to 
receive  altogether  $5,000.  Nothing  has  been  received  in 
June  and  there  are  to  be  no  further  expenses  to  Armstrong, 
the  amount  incurred  in  May  representing  the  fee  paid  to, 
and  the  expenses  of,  an  engineer  who  took  Armstrong's 
place  while  the  latter  was  incapacitated  by  illness. 

(d)  "Report  Earnings"  contains  fees  received  under 
contracts  for  reports  on  properties,  the  contracts  being 
exactly  similar  to  Contracts  1-2-3.    The  account  represents: 

1.  Received  on  account  of  contracts  on  which  nothing 

has  been  done  up  to  June  30,  19 16,  $8,500. 

2.  Balance  earned. 

(e)  "Stocks  and  Bonds"  represents  the  credit  balance 
of  the  general  investment  account ;  all  the  securities  at  one 
time  included  in  this  account  have  been  sold. 

(f)  The  "Expense  Account"  is  composed  of:  salary — 
Armstrong,  $6,000;  other  salaries,  $1,700;  rent,  $900;  ad- 
vertising, $700;  telegrams,  $90;  office  expenses,  $150;  other 
expenses,  $160. 

(g)  Interest  represents:  debits  charged  by  A.  B.  C. 
brokers  on  margin  account,  $1,300;  paid  on  loans  since 
liquidated,  $185.30;  credits:  dividends  on  stocks  still  held, 
credited  by  the  brokers,  $400. 

(h)  From  June  30,  191 5,  to  June  30,  19 16,  there  was 
received  as  dividends  on  stocks,  $1,750;  o^  this  amount 
$1,000  was  placed  to  the  credit  of  stocks  still  held  at  June 
30,  1916;  the  balance  went  to  the  credit  of  general  invest- 
ment account  "Stocks  and  Bonds." 

Required : 
Journal  entries  necessary  to  adjust  the  books  of  Vin- 
cent Armstrong  and  make  them  conform  to  account- 
ing principles. 


C42  PRACTICAL    PROBLEMS 

PROBLEM    XIII 

To  illustrate  the  necessity  of  analytical  accounting,  and 
the  accounting  meaning  of  terms  "Book  Value,"  "Replace- 
ment Value,"  "Depreciated  Book  Value,"  "Providing  for 
Reserves  by  Re  appraisement"    (See  CJmpter  XXXII.) 

An  analysis  of  the  "Property,  Plant,  and  Equipment" 
of  a  corporation  which  began  business  January  i,  1914, 
reveals  the  following  at  December  31,  1916: 

Total  book  value  of  the  account $1,01 1,340.00 

Analysis : 

Land— Cost    $50,000.00 

Buildings— Book  Value 575,000.00 

4  factory  buildings,  built  of  stone  and  brick,  costing  each 
$140,000,  erected  in  1914,  estimated  to  last  35  years;  not 
depreciated ;  3  store  houses  valued  at  $5,000  each,  built  of 
wood  and  tin ;  erected  in  1914,  estimated  to  last  10  years ; 
not  depreciated. 

Factory  Equipment — Cost 45,000.00 

Boiler  Plant,  costing  $16,000,  installed  in  1914,  not  de- 
preciated. 

Power  Plant,  costing  $18,500,  installed  in  1914,  estimated 
to  last  15  years ;  not  depreciated. 

Belting,  Shafting,  Pulleys,  costing  $10,500,  installed  in 
1914,  estimated  to  last  10  years;  not  depreciated;  no 
charges  to  account  other  than  cost 

Machinery — Book  Value 320,000.00 

40  machines  as  follows : 

20 — Universal  standard  machines,  cost,  $10,000  each, 
purchased  new  in  1914,  estimated  to  last  15  years,  with 
residual  value  of  $2,000  each.  Not  depreciated.  No 
charges  to  account  other  than  cost. 

15 — Special  machines,  average  cost,  $7,500  each,  con- 
structed in  1914  for  the  requirements  of  the  factory; 
estimated  to  last  10  years,  with  residual  value  of  $500 
each  and  minimum  annual  repairs  of  $100  per  machine; 
$500  charged  to  income  in  1915-1916  for  repairs  on  all 
these  machines.  Not  depreciated.  These  machines  are 
subject  to  being  discarded  long  before  their  estimated 
life,  if  better  machines  are  invented  for  the  line  of  work 


PRACTICAL    PROBLEMS 


543 


which  they  do.  Experience  has  shown  that  machines  of 
this  kind  become  obsolete  about  every  five  years,  and 
have  a  residual  value  of  $150. 

5 — Second-hand  machines,  cost,  $1,500  each,  acquired  in 
1915,  estimated  to  last  5  years,  with  a  residual  value  of 
$60  each. 

Machine  Tools — Book  Value  12/3 1/16 14,000.00 

Original  cost,  1914,  $18,000;  written  off  the  account  in 

1915,  $2,000.    In  1916,  $2,000,  when  issued  to  factory.    In 

1916,  purchases  amounting  to  $5,340  were  charged  to  fac- 
tory expense. 

Shop  Tools — Book  Value  12/31/16 7,340.00 

Issued  to  factory,  credited  to  Tools  account,  and  charged 
to  factory  expense : 

1914 $1,450.00 

1915 1,840.20 

1916 1,530.40 

Purchased    in    1916,    and    charged    to    factory    expense, 
$2,130.20. 
Sundry  items  of  equipment,  amounting  to  $1,390,  charged  to 
factory  expense  when  acquired  in  1915.  

$1,011,340.00 


An  independent  appraisal  has  been  made  at  the  same 
time  as  the  investigation.  The  appraisal,  as  recapitulated 
by  the  appraisers,  shows  the  following  results : 

Replacement  Depreciated 

Value  Value 

12/31/16  12/31/16 

Buildings— Stone,  Brick  and  Steel $568,000.00  $560,000.00 

Buildings— Frame  and  Tin 17,000.00  12,000.00 

Boiler  Plant 17,500.00  14,500.00 

Power  Plant 19,000.00  17,000.00 

Belting,  Shafting  and  Pulleys 12,000.00  9,000.00 

Machines— Universal  Standard 203,000.00  200,000.00 

Machines— Special 114,000.00  93,000.00 

Machines— Other  8,000.00  5,100.00 

Machine  Tools 23,000.00  20,800.00 

Shop  Tools 9,450.00  7,000.00 

Other  Equipment 1,500.00  950.00 

$992,450.00  $939,350.00 


544 


PRACTICAL    PROBLEMS 


The  appraisal  company  recommends  that  the  book  value 
of  property  appraised  be  increased  to  the  replacement  value. 

Inasmuch  as  some  of  the  work  in  erecting  the  buildings 
has  been  done  by  the  employees  of  the  company;  and  as, 
further,  the  basing,  erecting,  and  fitting  of  the  machinery, 
machine  tools,  and  equipment  has  been  done  by  factory 
hands  with  material  taken  from  stores  (which  facts,  how- 
ever, are  not  disclosed  by  the  analysis  made  by  the  com- 
pany), the  directors  realize  that  their  property  and  plant  is 
probably  undervalued.  Accordingly,  they  accept  the  sug- 
gestion of  the  appraisal  company,  and  decide  that  the  ac- 
count "Property,  Plant,  and  Elquipment"  is  to  be  divided 
into  its  component  parts  at  December  31,  19 16,  and  stated  at 
the  replacement  value  arrived  at  by  the  appraisers. 

Reserves  for  depreciation  are  to  be  created  on  the  basis 
of  the  depreciated  values,  ^  as  of  191 5,  and  J^  as  of  19 16. 

Required : 

1.  Journal  entries  setting  up  the  component  parts  of 

the  property  account  on  the  basis  of  the  com- 
pany's figures  adjusted  so  as  to  reflect  the  true 
cost  of  the  individual  units. 

2.  Journal  entries  adjusting  the  books  on  the  basis 

of  the  replacement  value,  and  providing  for  re- 
serves for  depreciation. 


PROBLEM    XIV 

From  the  New  York  C.  P.  A.  Examination  of  June, 
1898.   (See  Chapter  XXXIII.) 

The  balance  sheet  of  a  joint-stock  company,  January 
I,  1897,  shows  the  following  state  of  affairs : 


PRACTICAL    PROBLEMS 


545 


Capital  Stock $200,000.00 

Creditors  —  Open  Ac- 
counts       16,000.00 

Bills  Payable 30,000.00 

Profit  and  Loss  Ac- 
count       30,500.00 


$276,500.00 


Real  Estate $50,000.00 

Plant  and  Machinery. . .  85,000.00 

Horses  and  Wagons...  15,000.00 

Patents  and  Good- Will  20,500.00 

Inventory 49,000.00 

Accounts  Receivable...  35,000.00 

Cash  in  Bank 22,000.00 


$276,500.00 


A  year  later,  January  i,   1898,  after  an  audit  of  the 
books  and  accounts,  the  balance  sheet  stands  as  follows : 


Capital  Stock $200,000.00 

Creditors  —  Open     Ac- 
counts       17,000.00 

Mortgage 25,000.00 

Profit    and    Loss    Ac- 
count : 
Balance  last 

year $30,500.00 

Profit  this 
year 23,400.00    53,900.00 


$295,900.00 


Real  Estate $52,000.00 

Plant  and  Machinery : 
Balance  Jan. 

I,   1897. .  .$85,000.00 
Less    depre- 
ciation . . .     8,500.00    76,500.00 


Horses  and  Wagons: 

Balance  Jan. 
1,   1897... $15,000.00 

Less  depre- 
ciation . . .     2,250.00    12,750.00 


Patents  and  Good- Will 

20 

500.00 

Inventory 

65 

000.00 

Accounts  Receivable. . . 

33 

000.00 

Agency  Investments.. . 

IS 

000.00 

Cash  in  Bank 

21,150.00 

$295 

900.00 

From  the  foregoing  it  will  be  seen  that  for  the  year 
a  net  profit  of  $23,400  has  been  earned,  while  the  accounts 
receivable  are  smaller,  and  the  cash  balance  on  hand  is  less 
than  at  the  beginning  of  the  year,  though  no  dividend  has 
in  the  meantime  been  paid.  Prepare  account  showing  what 
has  become  of  the  profits  earned. 


546 


PRACTICAL    PROBLEMS 


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PRACTICAL    PROBLEMS  CAy 

PROBLEM    XVI 

Based  upon  the  systemaiization  of  hooks  of  account  for 
the  purpose  of  facilitating  financial  statements,  and  upon 
the  closing  journal  entries  necessary  to  group  certain  facts 
to  be  included  in  said  statements.  From  the  New  York 
C.  P.  A.  Examination  of  June,  ipi2.  (See  Chapters  XXXV, 
XXXVII.) 

The  following  balances  are  taken  from  the  books  of 
the  Roberts  Manufacturing  Company  of  New  York  City, 
on  December  31,  1910: 

Inventory  of  Finished  Goods  (January  i) $3,684.57 

Inventory  of  Raw  Materials  (January  i) 11,392.76 

Purchases  of  Raw  Materials 62,519.85 

Sales  217,387.42 

Wages   109,317.88 

Rent  19,500.00 

Discounts  Received  on  Purchases 375.6o 

Discounts  Allowed  on  Sales 186.36 

Power,  Light,  and  Heat 8,710.64 

Light  and  Heat  for  Office 168.00 

Repairs 1,090.00 

Packing  2,017.00 

Factory  Expense 3,270.00 

General   Expense 5,230.00 

Factory  Insurance 1,050.00 

General  Insurance 75o>0O 

Machinery  and  Plant 12,350.00 

Tools    2,600.00 

Commissions    7,642.00 

Office  Salaries 9,700.00 

Salesmen's  Salaries 8,930.00 

Interest  on  Loans 440.00 

Loans    Payable 22,000.00 

Discount  Lost 120.00 

Notes  Receivable 130,000.00 

Notes  Receivable,  Discounted 8,000.00 

Notes  Payable I9,500.oo 

Accounts  Receivable 101,026.00 


548 


PRACTICAL    PROBLEMS 


Accounts  Payable 30,020.00 

Office  Furniture 1,100.00 

Furniture  and  Fixtures 1,950.00 

Cash  on  Hand 1,825.00 

Cash  in  Banks 26,467.00 

Returned  Sales 276.00 

Capital    Stock 200,000.00 

Reserve  for  Depreciations 3,236.98 

Reserve  for  Bad  Debts 5,727.00 

Freight  and  Cartage  Inward 727.00 

Stable  Expenses 2,750.00 

Horses,  Wagons  and  Harnesses 8,500.00 

Postage  and  Expressage 1,250.00 

Superintendence 3,500.00 

Taxes 250.00 

Good-Will 10,000.00 

Stationery  and  Printing 1,080.00 

Advertising 8,630.00 

Surplus   (1909) 63,753.00 

1.  Prepare  from  the  above  a  trial  balance  arranged  in 
systematic  order,  so  as  to  facilitate  the  preparation  of  fi- 
nancial or  business  statements. 

2.  Draft  journal  entries  for  closing  the  books. 

3.  Certify  your  results  by  a  balance  sheet.  Support 
the  surplus  shown  by  the  balance  sheet  by  a  statement  of 
income  and  profit  and  loss. 

The  following  items  are  to  be  taken  into  consideration : 

Inventories : 

Raw  Materials '. $16,250.00 

Finished   Goods 9,386.00 

Tools   2,000.00 

Office  Furniture 1,000.00 

Furniture  and  Fixtures 1,500.00 

Stationery  and  Printing 300.00 

Allow  for  depreciations:  on  machinery,  5% ;  on  horses, 
wagons  and  harnesses,  10%. 

Reserve  for  bad  debts:  3%  on  accounts  receivable  only. 


PRACTICAL    PROBLEMS  ^49 

The  item  for  rent,  $19,500,  is  to  be  apportioned  as  fol- 
lows: 53%  for  factory,  22%  for  salesrooms,  and  25%  for 
office. 

The  item  of  superintendence,  $3,500,  is  to  be  divided, 
3/5  to  factory  and  2/5  to  general  expense. 


PROBLEM  XVII 

Based  on  the  application  of  double-entry  principles  to  the 
establishment  of  financial  statements  —  introducing  the 
technique  of  journalising,  and  the  theories  which  underlie 
the  various  forms  assumed  by  the  said  statements.  (See 
Part  V.) 

Armstrong  &  Campbell  accept  the  ofifer  made  to  them 
by  H.  Dover  on  July  i,  by  which  he  is  to  invest  $25,000 
in  the  business,  becoming  a  special  partner,  and  sharing 
to  the  extent  of  one-fifth  in  their  profits.  On  July  2 
Dover  agrees  to  exert  all  his  business  ability  towards  the 
welfare  of  the  concern.  He  pays  to  the  business  an  addi- 
tional $5,000  in  cash;  this  is  to  be  treated  as  additional 
capital  invested  by  J.  Armstrong  and  A.  Campbell  equally 
and  is  in  the  light  of  a  payment  by  Dover  to  the  old  partners 
personally  for  their  services  in  acquiring  the  good-will  which 
the  business  possesses.  The  value  of  good-will  has  been 
agreed  to  be  $6,000. 

The  new  articles  of  copartnership  provide  that  the  part- 
ners shall  share  in  the  profits  to  the  extent  of,  Armstrong, 
two-fifths;  Campbell,  two-fifths;  Dover,  one-fifth.  No  in- 
terest is  to  be  credited  on  capital  invested. 

A  new  bookkeeper  has  been  engaged  by  the  firm,  and 
at  July  31,  1916,  he  presents  the  following  trial  balance: 


550 


PRACTICAL    PROBLEMS 

Trial  Balance,  July  31,  19 16 


Debits 

Cash  $45,961.90 

Land  and  Building 6,000.00 

Furniture  and  Fixtures.  975-00 
Horse,  Wagon  and  Har- 
ness    3,150.00 

Good- Will 6,000.00 

Merchandise  Inventory..  59,843.04 
Freight  Inward  on  Pur- 
chases Sold 662.80 

Freight  Inward  on  Pur- 
chases Unsold 95.90 

Trade     Discount  —  Cus- 
tomers      1,614.60 

Allowances  on  Defective 

Sales 307.20 

Freight  and  Cartage, 

Outward 101.50 

Heat  and  Light 6.40 

Stable  Expenses 112.15 

Salaries — Clerks  160.00 

"      — Partners 100.00 

"      — Salesmen 300.00 

Sundry  Expense 65.00 

Accounts  Receivable 20,238.67 

Notes  Receivable 8,200.00 

Foreign  Exchange 12.30 

Legal  Expense 60.00 

Purchases — Merchandise  25,350.30 

Sales  Returned 2,647.87 


$181,964.63 


Credits 

Returned  Purchases $1,960.30 

Sales 72,105.00 

Interest    on    Bank    Bal- 
ance           22.10 

Commission  —  Consign- 
ment          345-i8 

Trade    Discount — Credi- 
tors        1,085.50 

Allowances  on  Purchases  241.26 
1st     Mortgage,     Payable 

1918 2,500.00 

Notes  Payable 1 1,400.00 

Accounts   Payable 10,640.21 

J.  Armstrong,  Capital...  29,265.30 
A.  Campbell,  "  ...  27,399.78 
H.  Dover,  "       ...  25,000.00 


$181,964.63 


The  following  facts  are  submitted: 

Inventory,  July  31,  1916:  merchandise,  $28,423.34. 
Notes    receivable;    notes    outstanding    July    i,    1916, 
collected,  $9,800;  new  notes  received,  $6,000. 


PRACTICAL    PROBLEMS 


551 


Notes  payable:  notes  outstanding  July  i,  19 16,  paid, 

$26,600;  new  notes  given,  $8,000. 
Consignments — all  sold,  all  sales  collected ;  allowances : 

No.  I,  $4.50;  No.  2,  $6.20;  freight  on  sales:  No.  i, 

$30.10;  No.  2,  $45.02;  No.  3,  $2.25.     Balance  due 

to  consignors,  remitted. 
Stable  expense — 50%  applicable  to  freight  and  cartage 

inward ;  the  balance  applies  to  goods  sold. 

From  the  foregoing,  and  from  the  facts  in  Problem  IV, 
prepare : 

1.  The  journal  entries  incident  to  the  admission  of 

the  new  partner,  and  to  the  closing  of  the  books. 

2.  Statement  of  income  and  profit  and  loss. 

3.  General  balance  sheet. 

4.  Trading  and  profit  and  loss  account  subdivided  into 

sections  corresponding  to  the  main  groups  of 
facts  found  in  the  "Statement  of  Income  and 
Profit  and  Loss." 

5.  Account  sales  to  consignor  No.  i  from  March  to 

July,  19 16,  both  inclusive. 


PROBLEM   XVIII 

From  the  New  York  C.P.  A.  Examination  of  February, 
ipio.   (See  Part  V.) 

The  directors  of  a  manufacturing  company,  before  the 
closing  and  auditing  of  the  books  for  the  half  year  ending 
December  31,  declared  out  of  the  net  earnings  of  the  com- 
pany, a  dividend  for  the  half  year  of  4%  on  the  preferred 
stock  of  $100,000  and  3%  on  the  common  stock  of  $100,000. 


552 


PRACTICAL    PROBLEMS 


There  has  been  brought  forward  from  the  last  half  year  an 
undivided  balance  of  profit  of  $4,ocx)  and  after  the  audit 
of  the  books  the  trial  balance  is  found  to  be  as  fol- 
lows: 


Trial  Balance,  December  31 


Real   Estate  and  Build- 
ing   $32,500.00 

Plant  and  Machinery. . .  40,000.00 
Patents  and  Good-Will.  80,000.00 

Inventory,  July  i 29,000.00 

Purchases   82,500.00 

Labor  88,000.00 

Coal 6,000.00 

Salaries — General 11,000.00 

Salaries — Management ..     5,000.00 

Insurance    875.00 

Allowances 6,250.00 

Freight 1,500.00 

Discount  and  Interest. . .       750.00 

Cash  in  Bank 8,000.00 

Investments 15,500.00 

Miscellaneous  Expense. .     4,300.00 

Book  Debts 42,000.00 

Preferred    Stock   in 

Treasury 5,000.00 

Repairs 1,000.00 

$459,17500 


Preferred  Stock $100,000.00 

Common  Stock 100,000.00 

Sales 219,175.00 

Notes  Payable 26,000.00 

Accounts  Payable 14,000.00 


$459,175.00 


Stock  on  hand,  $26,500.  From  the  above  prepare 
profit  and  loss  and  income  statement  and  balance  sheet, 
giving  effect  in  accounts  to  depreciation  at  the  rate  of 
75^%  a  year  on  plant  and  machinery,  and  making  an 
allowance  of  5%  on  the  book  debts  to  provide  for  bad 
debts;  also  create  a  liability  in  the  balance  sheet  for 
dividend  as  stated. 


PRACTICAL    PROBLEMS 
PROBLEM    XIX 


553 


Introducing  one  of  the  methods  of  merging  corporations. 
From  the  New  York  C.  P.  A.  Examination  of  January, 
19 1 2.   (See  Part  V.) 

The  Burnwell  Gas  Company  is  incorporated  on 
January  i,  1910,  with  an  authorized  capital  of  $300,000 
(2/3  preferred  stock  and  1/3  common),*  to  acquire  and 
conduct  the  business  of  the  Safety  Gas  Company,  whose 
general  balance  sheet  shows  the  following  on  December  31, 
1909: 


Buildings,  Machinery 
and  Equipment $ 

Notes  Payable 

. . .  $10,000.00 

100,000.00 

Accounts  Payable .  • . 

. . .     52,000.00 

Mains,  Conduits,  Meters 

Capital 

Stock 

. . .  20o,ooaoo 

70,000.00 

Surplus 

. . .    30,000.00 

Franchises,     Rights, 

Privileges,  etc 

50,000.00 

Materials  and  Supplies. 

15,000.00 

Tools    and    Emergency 

Equipment 

10,000.00 

Cash  

11,800.00 

Accounts  Receivable. . . 

35,200.00 

$292,000.00 

$292,000.00 

On  January  15,  1910,  all  the  preferred  and  common 
stock  of  the  Burnwell  Gas  Company  was  issued  to  the 
20  stockholders  of  the  Safety  Gas  Company,  in  exchange 
for  their  holdings  of  stock  of  the  latter  company,  in  the 
proportion  of  one  share  of  preferred  and  one  share  of 
common  for  each  share  of  stock  exchanged. 

At  a  meeting  of  the  board  of  directors  of  the  Safety 

•The  original  problem  reads:  "All  the  shares  being  of  the  par  value  of  $ioo." 
As  this  is  unworkable  from  the  point  of  view  of  the  issue  of  stock,  the  problem 
has  been  changed  to  read  as  above.    The  error  is  evidently  due  to  »  misprint. 


554 


PRACTICAL    PROBLEMS 


Gas  Company,  held  January  20,  19 10,  it  was  resolved  to 
carry  out  the  provisions  of  a  plan  of  merger  in  accordance 
with  which  the  Safety  Gas  Company  was  to  transfer  its 
assets  and  liabilities  to  the  Burnwell  Gas  Company  and 
surrender  its  charter.  A  certificate  of  merger  was  issued 
at  the  close  of  the  meeting. 

At  a  meeting  held  January  31,  19 10,  the  board  of  di- 
rectors of  the  Burnwell  Gas  Company  resolved  to  open  ac- 
counts on  the  general  books  of  the  company,  with  the  in- 
dividual assets  and  liabilities  taken  over  and  assumed,  at 
the  figures  shown  by  the  balance  sheet  of  the  Safety  Gas 
Company  at  December  31,  1909,  with  the  following  excep- 
tions: (a)  franchises,  etc.,  to  be  raised  to  $70,000;  (b)  sur- 
plus not  to  be  carried. 

As  to  the  January  operating  transactions,  they  were 
recorded  in  special  books,  in  order  that  they  might  be  em- 
bodied at  the  proper  time  in  the  books  of  the  Burnwell  Gas 
Company. 

Prepare : 

1.  Chronological  journal  entries  reflecting  on  the  books 

of   the    Burnwell    Gas    Company    the    different 
stages  of  the  merger. 

2.  A  journal  entry  closing  the  books  of  the  Safety 

Gas  Company. 


PROBLEM  XX 

To  introduce  the  subject  of  the  holding  company,  and  to 
illustrate  the  theory  of  consolidated  balance  sheets.  (See 
Chapter  XXXVIIL) 

The  Great  Eastern  Securities  Company  is  organized  un- 
der the  laws  of  the  State  of  New  Jersey,  "to  purchase,  hold, 


PRACTICAL    PROBLEMS 


555 


sell,  assign,  transfer,  pledge,  or  otherwise  dispose  of  the 
shares  of  the  capital  stock  of,  or  any  bond,  securities,  or 
other  evidences  of  indebtedness  created  by,  any  other  cor- 
poration or  corporations  of  this  or  any  state." 

The  company  has  an  outstanding  capital  stock  of 
$6,000,000,  represented  by  60,000  shares  of  common 
stock,  which  has  all  been  subscribed  and  50%  paid  in. 

In  July,  19 1 6,  the  Up-State  Electric  Lighting  Company, 
doing  business  in  the  State  of  New  York  and  capitalized  at 
$1,000,000,  of  which  $200,000  is  preferred  stock,  and 
having  an  outstanding  issue  of  $500,000  of  6%  bonds  due 
August  15,  1916,  finds  itself  so  discredited,  owing  to  bad 
management  and  losses  due  to  floods,  that  it  cannot  hope 
to  provide  funds  to  retire  the  issue  of  bonds  at  maturity. 
In  the  course  of  the  life  of  the  bonds,  the  Up-State  Com- 
pany has  created  an  adequate  reserve  for  its  bonded  in- 
debtedness, which  now  equals  the  liability  for  bonds,  but 
has  not  been  funded. 

The  Up-State  Company  has  a  surplus  of  $175,000,  but 
among  its  assets  there  is  an  investment  of  $250,000,  rep- 
resenting cost,  amortized  to  par,  of  6%  sewer  bonds  of  the 
City  of  Rochester  and  Town  of  Gates.  These  bonds  were 
defaulted  as  to  principal  in  19 14,  the  City  of  Rochester 
having  disclaimed  liability  thereunder. 

The  Great  Eastern  Company,  being  cognizant  of  the 
financial  distress  of  the  Up-State  Company,  offers  to  pur- 
chase its  whole  capital  stock  outstanding,  paying  $98  for 
the  preferred  and  $95  for  the  common.  It  also  offers  to 
advance  to  the  Up-State  Company  $500,000  to  retire  out- 
standing bonds  at  maturity,  and  to  purchase  at  $94  the 
whole  of  a  new  issue  of  bonds  amounting  to  $500,000,  due 
1930,  to  be  made  by  the  Up-State  Company,  and  to  be 
secured  by  the  same  mortgage  now  covering  the  issue  to 
be  retired. 


556 


PRACTICAL    PROBLEMS 


The  Great  Eastern  Company  further  proposes  to  ac- 
quire, at  50%  of  their  face  value,  the  sewer  bonds  held 
by  the  Up-State  Company.  The  purchaser  has  informa- 
tion leading  to  the  belief  that  50  or  60%  of  the  face  value 
of  the  securities  will  eventually  be  paid  to  the  bond- 
holders. 

The  negotiations  go  through,  and  all  these  transac- 
tions take  place  during  the  month  of  August.  The  whole 
capital  stock  of  the  Great  Eastern  Company  is  issued  in 
August. 

The  balance  sheet  of  the  Up-State  Electric  Company 
at  the  time  of  the  acquisition  of  that  company's  stock  by 
the  Great  Eastern  Securities  Company  was  as  follows: 


Land  and  Buildings. .  .$550,750.00 
Machinery,    Service 

Lines  and  Mains. . .  .1,079,380.00 

Tools  and  Supplies 124,350.00 

Cash 30,150.00 

Investments  250,000.00 

Accounts  Receivable...  182,750.00 
Deferred     Charges     to 

Income   7,350.oo 

$2,224,730.00 


Capital  Stock: 

Preferred    $200,000.00 

Common    800,000.00 

6%  Bonds,  1916 500,000.00 

Accounts  Payable 49,730.00 

Surplus 175,000.00 

Reserve  for  Redemption 
of  Bonds 500,000.00 


$2,224,730.00 


Required : 
I.    The  journal  entries  expressing  the  above  transac- 
tions on  the  books  of  the  Great  Eastern  Securi- 
ties Company. 

The  balance  sheet  of  the  Great  Eastern  Securities 
Company  at  August  31,  19 16. 

The  balance  sheet  of  the  Up-State  Electric  Light- 
ing Company  at  August  31,  19 16. 

The  consolidated  balance  sheet  of  the  two  com- 
panies at  August  31,  1916. 


2. 


4- 


PRACTICAL    PROBLEMS  557 

PROBLEM    XXI 

Illustrating  the  technique  of  the  consolidated  balance 
sheet.    (See  Chapter  XXXVIII.) 

The  F.  L,  Company  owns  the  stock  of  two  operating 
companies ;  the  investment  stands  on  its  books  at  $500,000, 
for  which  the  holding  company  issued  its  own  stock  in  the 
amount  of  $200,000  of  preferred  and  $200,000  of  common, 
and  $100,000  of  5%  gold  bonds.  The  authorized  capital 
stock  of  the  holding  company  is  $500,000,  $300,000  being 
preferred;  the  authorized  bond  issue  is  $100,000;  the  capital 
stock  is  all  issued,  full-paid,  and  non-assessable.  The  bal- 
ance sheet  of  the  operating  companies,  at  the  time  the  hold- 
ing company  purchased  their  stock,  was  as  follows: 

Assets 

Co.  X         Co.  Y 

Land,  Buildings  and  Realty  Fixtures* $50,000.00      $74,000.00 

Machinery  and  Machine  Tools 45,000.00        39,000.00 

Plant  Movable  Equipment 10,000.00          7,000.00 

Shop  and  Hand  Tools 6,000.00          3,000.00 

Furniture  and  Personalty  Fixtures 4,900.00          5,000.00 

Office  Equipment 1,050.00         1,740.00 

Goods  in  Progress 15,000.00        17,300.00 

Finished  Goods 7,5oo.oo        11,800.00 

Raw  Materials 17,000.00        21,850.00 

Sundry  Factory  Supplies 3.5oo.oo         6,650.00 

Investments : 

Bonds,  Company  Y 50,000.00 

Bonds,  Other  Industrial  Companies 10,000.00 

Accounts  Receivable 34,850.00       31,580.00 

Cash 3,94100       30,500.00 

Demand  Notes  Company 5,000.00 

Accrued  Interest: 

Bonds,  Company  Y 1,500.00 

Bonds,  Other  Industrial  Companies 300.00 

Advances — Company  X 10,000.00 

$265,541.00    $259,420.00 

•Depreciation  charged  to  cost  of  goods,  deducted  from  the  asset  in  the 
amount  of  $9^500. 


558  PRACTICAL    PROBLEMS 

Liabilities 

Co.  X         Co.  Y 
Capital  Stock: 

Preferred  $100,000.00 

Common   100,000.00      $50,000.00 

Bonds : 

Principal  150,000.00 

Interest  4,500.00 

Notes  Payable 2,000.00        15,000.00 

Advances  Payable 10,000.00 

Accounts  Payable 15,300.00         9,345.00 

Surplus : 
Reserved : 
For  Depreciation  of  Physical  Assets    (not 

charged  to  cost  of  goods) 11,300.00 

For  Redemption  of  Bonds 7,500.00 

For  Doubtful  Accounts  Receivable 1,035.00  637.00 

Available  for  Dividends 37,206.00        1 1,138.00 

$265,541.00    $259,420.00 

Required : 

The  consolidated  balance  sheet  of  the  three  companies, 
established  in  accordance  with  the  request  of  the 
board  of  directors  of  the  F.  L.  Company  for  exact 
information  as  to  the  properties  which  the  latter 
company  controls. 


PROBLEM    XXII 

Introducing  a  discussion  of  the  effect  of  the  rulings  of 
the  Interstate  Commerce  Commission  upon  generally  ac- 
cepted accounting  theories  and  methods.    (See  Part  V.) 

From  the  following  trial  balance  after  closing  and  the 
footnotes  attached,  prepare  the  balance  sheet  of  the  Blank 
Railroad  Company  as  at  December  31,  1916,  in  accordance 
with  the  rulings  of  the  Interstate  Commerce  Commission, 
effective  July  i,  19 14. 


PRACTICAL    PROBLEMS 

Trial  Balance 


559 


(1)  Investment  in  Road 

and  Equipment.  .$17,900,900 

(2)  Mi  sc  e  llaneous 

Physical  Property      684,750 

(3)  Expenditures  on 

Leased    Railway 
Property 360,000 

(4)  Sinking  Funds : 

(a)  ForRedemp- 

t  i  o  n  of 
Equipment 
Certificate..       465,900 

(b)  ForRedemp- 

t  i  o  n  of 
Mortgage 
Bonds 550,000 

Investments : 

(5)  (a)  Investments 

in  Affiliated 
Companies .     2,355,000 

(6)  (b)  Other    In- 

vestments.. 396,500 

(7)  Cash 1,943.900 

(8)  Deposits  and  Loans  3,968,600 

(9)  Accounts  Receiv- 

able         694,000 

(10)  Materials  and  Sup- 

plies         315,000 

(11)  Interest  and  Rents 

Receivable    360,150 

Working  Funds  in 

Hands  of  General 

and    Special 

Agents 18,410 

Rentals    Paid    in 

Advance  1,150 

Insurance  Paid  in 

Advance 5,68o 

(12)  Suspense   Account       284,471 
Discounts  on  Cap- 
ital Stock  (net).         18,560 


Capital  Stock: 

(a)  Preferred  . .  $5,000,000 

(b)  Common  . . .   10,000,000 

(14)  Funded  Debt 7,348,900 

(15)  Accounts  Payable.  798,190 

Loans  Payable 500,000 

Unmatured   Divi- 
dends Declared..  2,300,000 

(16)  Accrued  Liabilities  23,050 
Premiums  on  Fund- 
ed Debt 41,030 

Premium  on  Cap- 
ital Stock 29,645 

(17)  Land  Grants 300,000 

(18)  Reserves    3,3i3,i90 

Profit  and  Loss 3,008,072 


^60  PRACTICAL    PROBLEMS 

Trial  Balance — Continued 


Discounts  on  Fund- 
ed Debt  (net)  . . .         39,io6 
(13)  Securities  Issued — 

Unsold 2,300,000 


$32,662,077 


$32,662,077 


(i)  Credits  for  abandoned  property  subsequent  to  June,  1916,  $75,000. 

(2)  As  follows:  mines,  $150,000;  hotels  and  restaurants,  $75,000;  tim- 

ber lands,  $160,000;  land  and  buildings  not  used  for  operations, 
$250,000;  materials  leased  to  others,  $49,750. 

(3)  Expenditures  represent  improvements. 

(4)  As  follows:    (a)   cash,  $155,000;   securities  of  other  companies, 

book  value,  $310,900;  (b)  cash,  $50,000;  securities  issued  by  the 
company  (par  value),  $500,000. 

(5)  Stocks,    $1,550,000;    bonds,    $600,000;    notes,    $75,000;    advances, 

$130,000. 

(6)  Stocks,  $250,000;  bonds,  $100,000;  advances,  $36,000;  miscellaneous, 

$10,500. 

(7)  As  follows:  deposits  subject  to  check,  $1,850,000;  sight  drafts  and 

sight  bills  of  exchange  credited  to  remitters,  $75,000;  cash  in 
offices,  $18,900. 

(8)  As   follows :   demand  loans   fully  secured,  $60,000 ;   demand  de- 

posits, banks,  $159,000;  time  drafts  receivable,  $45,800;  time 
deposits,  banks,  $800,000;  deposits  for  dividends,  $2,300,000; 
guarantee  deposits  (contracts  for  construction),  $500,000;  de- 
posits for  injuries,  $49,800;  unsecured  loans  and  bills,  maturity 
less  than  one  year,  $54,000. 

(9)  As  follows :  traffic  and  car  service  balances,  $609,000 ;  due  from 

conductors  and  agents,  etc.,  $39,800;  collectible  from  U.  S. 
Government  (mail),  $19,600;  individuals  and  companies,  $25,600. 

(10)  As    follows:    materials    in    stores,    cost,    $340,000;    depreciation, 

$25,000. 

(11)  As  follows:  interest,  $210,000;  rents,  $50,150;  dividends  declared 

on  stocks  owned,  $100,000. 

(12)  Contains:   remainder  of  value  of  property  abandoned  prior  to 

June,  1916,  $201,340;  property  abandoned  subsequent  to  June, 
1916,  $75,000;  freight  claims  paid,  not  investigated  so  far  as 
other  carriers  are  concerned,  $3,I0I ;  estimated  depreciation  on 
equipment  leased,  $5,030. 


PRACTICAL    PROBLEMS  561 

(13)  As  follows:  bonds,  $1,000,000,  of  which  $500,000  are  pledged  to 

secure  loans;  stocks  issued  and  reacquired  by  purchase,  not 
pledged,  $300,000.  Not  sold,  but  signed  and  ready  for  sale, 
$1,000,000. 

(14)  As  follows:   equipment  obligations,  $1,203,900;   mortgage  bonds, 

$5,600,000;  miscellaneous,  $395,000;  long  term,  non-negotiable 
notes  to  affiliated  companies,  $150,000. 

(15)  As  follows:   traffic  and  car  service  balances,  $701,450;   audited 

vouchers  unpaid,  $42,830 ;  wages  payable,  $50,200 ;  miscellaneous, 
$3,710. 

(16)  As  follows:  interest  accrued,  $11,300;  rents  accrued,  $4,650;  taxes 

accrued,  $7,100. 

(17)  Original  value  of  land  granted  in  aid  of  construction. 

(18)  Unapplied  balance  of  current  charges  to  equalize  revenue.    Main- 

tenance of  road  and  equipment,  $20,640;  injuries,  $49,800. 
Charges  to  operating  expense  for  depreciation  of  road,  $1,001,- 
500;  for  equipment,  $500,000;  miscellaneous  physical  property, 
$55,000.  For  redemption  of  mortgage  bonds,  $550,000;  for  re- 
demption of  equipment  certificate,  $465,900;  for  addition  to 
property,  $350,000;  for  funded  debt  now  retired,  $260,000; 
miscellaneous  reserves  not  specifically  invested,  $60,350. 


PROBLEM  XXIII 

To  illustrate  the  theory  of  the  statement  of  affairs  in 
connection  with  sole  proprietorship  and  copartnership  and 
the  meaning  of  the  deficiency  account.  (See  Chap- 
ter XXXIX.) 

On  October  i,  1916,  John  Doe  finds  himself  insolvent. 
His  creditors  may  agree  to  allow  him  to  settle  his  affairs 
under  the  provision  of  the  state  insolvency  laws,  as  he 
wishes  to  do,  but  they  withhold  their  decision  until  sub- 
mission to  them  of  a  statement  of  affairs.  John  Doe's  books 
show: 


562 


PRACTICAL    PROBLEMS 


Debits 

Cash $3,000.00 

Land  and  Building 40,000.00 

Furniture  and  Fixtures..  5,000.00 

Delivery  Equipment 3,000.00 

Merchandise     Inventory 

Sept.  30 32,000.00 

Accounts  Receivable 61,130.00 

Notes  Receivable  (no  in- 
terest)    8,000.00 

Insurance    on    Building, 

Unexpired 50.00 

Advertising  Unexpired..  100.00 

Salaries   2,620.00 

Expenses 4,155.40 

$159.05540 


Credits 
1st    Mortgage    5%,    due 

Dec.  31,  1916 $26,000.00 

Notes   Payable    (no   in- 
terest)    23,000.00 

Accounts  Payable 71,600.00 

Taxes  Due 130.00 

Salaries  and  Wages  Due       315.00 

Merchandise 5,140.25 

Interest    Accrued    on 

Mortgage 260.00 

Capital  32,610.15 


$159,055.40 


The  personal  debts  of  John  Doe  amount  to  $625,  rep- 
resented by  the  following: 

Due  to  Butcher $75-00 

"      "Grocer 89.40 

"      "    K.  T.  Realty  Co.  for  rent 350.00 

"      "   Constant  &  Sinclair,  Dry-Goods 110.60 

$625.00 


His  personal  property  is  as  follows : 

One  Horse,  valued  at $250.00 

One  Surrey  and  Harness,  valued  at 3SO.OO 

25  shares  of  Golden  Horn  Mining  Co.,  par,  $50. . .  1,250.00 

Cash  in  Southern  Bank 5ii-30 

.'■  

$2,361.30 


In  due  course  of  time  the  following  appraisals  are  ob- 
tained : 


PRACTICAL    PROBLEMS  .63 

Land  and  building,  $42,000;  furniture  and  fixtures, 
$3,000;  delivery  equipment,  $2,100;  merchandise  in- 
ventory, $25,000. 

The  accounts  receivable  are  found  to  be : 
Good,  $29,600;  doubtful,  $15,650;  uncollectable, 
$15,880.  It  is  estimated  that  the  doubtful  accounts 
may  realize  $4,500;  the  notes  receivable  will  prob- 
ably be  met  at  maturity;  advertising  contracts  are 
lost;  insurance  refund  will  approximate  $17.10. 

As  to  personal  property : 
The  delivery  equipment  will  realize  $400;  the  market 
value  of  the  Golden  Horn  stock  is  $40  per  share. 

Required : 
A  statement  of  affairs  and  a  deficiency  account. 


PROBLEM  XXIV 

From  the  New  York  C.  P.  A.  Examination  of  January, 
1906.    (See  Chapter  XXXIX.) 

The  Parker  Construction  Company  is  unable  to  meet 
its  obligations  and  is  forced  into  liquidation.  At  the 
time  the  receiver  takes  charge  of  its  affairs,  the  following 
trial  balance  is  prepared  from  the  company's  books  : 

Cash $500.00 

Land  and  Buildings 10,000.00 

Mortgage  on  Land  and  Buildings $8,000.00 

Plant  and  Equipment 20,000.00 

Creditors 59,400.00 

Completed  Contract  Accounts  (Losses) 18,000.00 

Capital  50,000.00 

t 


5^4 


PRACTICAL    PROBLEMS 


Uncompleted  Contract  Accounts  (Outlay) 30,000.00 

Debtors'  Accounts  for  Completed  Contracts....  6,000.00 

Securities  Acquired  in  Settlements 15,000.00 

Inventory  of  Materials 2,000.00 

Expenses    6,500.00 

Profit  and  Loss  (Deficiency) 9,400.00 


$117,400.00    $117,400.00 


The  sureties  on  the  unfinished  contracts  estimate  that 
a  further  outlay  of  $20,000  will  be  required  to  complete 
the  work  and  realize  the  contract  price  of  $40,000,  and 
their  offer  to  take  over  the  materials  on  hand  for  $1,500, 
as  part  of  said  cost,  is  accepted  by  the  receiver.  Of  the 
securities  acquired,  $5,000  is  pledged  to  secure  $11,000  due 
creditors,  and  $10,000  is  pledged  to  secure  $9,000  due  credi- 
tors. The  company  owes  for  taxes  on  real  estate,  $100, 
and  for  salaries  and  wages  of  employees,  $1,200,  which 
sums  do  not  appear  on  the  books.  The  company  has  dis- 
counted customers'  notes  for  $3,000,  of  which  subsequent 
advices  indicate  that  $1,000  will  be  dishonored,  and  a  debtor 
owing  $1,500  on  unsecured  account  has  failed  and  disap- 
peared. It  is  estimated  that  the  amount  realized  on  land 
and  buildings  will  be  sufficient  to  satisfy  the  mortgage  only, 
and  that  plant  and  equipment  will  realize  only  60%  of  the 
book  value. 

Prepare  a  statement  of  affairs  and  deficiency  account. 


PROBLEM   XXV 

From  the  New  York  C.  P.  A.  Examination.  (See  Chap- 
ter XXXIX.) 

The  Republican  Asphalt  Contracting  Company  is  forced 
into  liquidation;  and  the  receiver,  when  taking  possession, 
finds  the  books  of  account  to  show : 


PRACTICAL    PROBLEMS 


S6S 


Liabilities 

Bills  Payable $18,000.00 

Creditors'  Open  Accounts 75,500.00 

Mortgage  on  Real  Estate  and  Improvements. . .  17,500.00 

Mortgage  on  Contracting  Equipment 7,000.00 

Capital    Stock    Subscribed $100,000.00 

Less  Not  Paid  Up 2,500.00  97,500.00    $215,500.00 


Assets 

Cash  in  Bank  and  Office $700.00 

Bills   Receivable 4,300.00 

Debtors'  Accounts 8,200.00 

Bonds  and  Warrants 23,000.00 

Real  Estate  and  Improvements 35,000.00 

Manufacturing  Plant 24,000.00 

Contracting    Equipment 14,000.00 

Uncompleted    Contracts    (Cost) 41,000.00 

Inventory  of  Materials  and  Supplies 3,500.00    $153,700.00 


The  bondsmen  on  the  unfinished  contract  estimate  that 
an  expenditure  of  $25,000  will  complete  the  uncompleted 
contract  and  realize  the  contract  price  of  $60,000,  and  their 
offer  of  $2,750  for  the  inventory  of  material  and  supplies 
as  part  of  said  expenditure,  is  accepted  by  the  receiver.  The 
company  owes  for  personal  taxes  and  adjustment  of  em- 
ployer's liability  premiums,  $175  and  $100,  respectively,  and 
unpaid  labor  accounts  amounting  to  $1,700,  which  amounts 
do  not  show  on  the  books  of  account. 

The  bills  receivable,  amounting-  to  $4,300,  are  pledged 
as  collateral  for  $3,500  due  creditors,  and  $20,000  of  the 
bonds  and  warrants  have  been  given  as  security  for 
$33,000  due  creditors,  $1,000  of  the  bills  receivable  is 
subsequently  dishonored. 

The  receiver  finds  that  $1,100  of  the  debtors'  accounts 
is  collectable.  The  sale  of  real  estate  and  improvements 
(book  value  of  $35,000)  realizes  $32,500;  manufacturing 


566  PRACTICAL    PROBLEMS 

plant,  40%  of  the  book  value;  contracting  equipment,  35% 
of  book  value. 

Prepare  a  statement  of  affairs  and  deficiency  account. 


PROBLEM   XXVI 

From  the  New  York  C.  P.  A.  Examination  of  June, 
ipoy.    (See  Chapter  XL.) 

The  Fox  and  Dix  Company,  a  close  corporation,  became 
embarrassed  through  the  failure  of  a  friendly  company  to 
whom  they  had  given  their  accommodation  paper,  and  a 
trustee  was  appointed  February  i,  1906,  to  take  charge  of 
their  affairs  for  the  benefit  of  the  creditors. 

The  condition  of  the  estate,  when  the  trustee  took  charge, 
was  as  follows: 

Liabilities 

Mortgage  on  Real  Estate,  maturing  February  i,  1907 $15,000.00 

Interest,  due  February  i,  1906,  six  months,  at  5% 375-00 

Taxes  Due 210.00 

Book  Accounts  Payable 3,900.00 

Bills  Payable  (including  accommodation  paper,  $56,000) 57,400.00 

Capital  Stock 40,000.00 

Surplus,  per  profit  and  loss  account 3,987.00 

$120,872.00 


Assets 

Cash  on  Hand  and  in  Bank $650.00 

Merchandise  (stock  of  goods) 25,310.00 

Book  Debts  (including  accommodation  account,  $56,000) 60,800.00 

Bills  Receivable 4,112.00 

Real  Estate 30,000.00 

$120,872.00 


PBLA.CTICAL    PROBLEMS 


567 


In  order  to  complete  contracts  and  so  realize  to  the  best 
advantage  on  the  goods  in  stock,  the  trustee  purchased  mer- 
chandise to  the  amount  of  $50,000,  and  during  the  year 
collected  $100,002  cash  from  sales. 

The  accommodation  account  was  settled  for  60%.  The 
other  book  debts  realized  $4,100,  and  the  bills  receivable, 
$3,600.     Balance,  lost. 

The  accommodation  paper  was  settled  by  paying  $40,- 
000  cash  and  renewing  $16,000,  entailing  legal  fees,  interest, 
and  petty  expenses  of  $2,200. 

The  other  bills  payable,  the  accounts  payable,  taxes  and 
interest  on  mortgage  for  eighteen  months,  were  paid  in 
course  of  settlement,  and  the  principal  of  the  mortgage  was 
paid  off  at  maturity. 

The  running  expenses  were  as  follows:  clerk  hire, 
$1,500;  office  expenses,  $1,000;  allowances  to  officers, 
$3,000;  trustee's  commissions,  $3,000. 

On  February  i,  1907,  the  trustee  surrendered  charge 
of  the  company's  offices  and  paid  over  the  cash  balances  in 
his  hands.  On  said  date  there  were  also  uncollected 
book  debts  amounting  to  $2,000,  and  merchandise  stock, 
$8,000. 

Prepare  a  realization  and  liquidation  account,  a  trustee's 
cash  account,  and  a  balance  sheet  of  the  estate  at  termina- 
tion of  trust. 


PROBLEM  XXVII 

From  the  Nezv  York  C.  P.  A.  Examination  of  June, 
ipi2.    (See  Chapter  XL.) 

The  following  is  the  trial  balance  of  the  Rawdeal  Com- 


568 


PRACTICAL    PROBLEMS 


pany,  June  i,  191 1,  on  which  day  the  directors  of  the  com- 
pany resolve  that  the  secretary  of  the  company  be  author- 
ized to  call  a  meeting-  of  the  stockholders,  to  vote  on  the 
immediate  dissolution  of  the  company: 


Land $15,000.00 

Building  and  Realty  Fix- 
tures    40,000.00 

Machinery  and  Machine 
Tools 35,000.00 

Shop   and    Hand   Tools 

(in  store) 5,000.00 

Furniture  and  Personalty 

Fixtures  9,700.00 

Raw  Materials  and 
Freight  thereon 10,350.00 

Accounts  Receivable 23,400.00 

Cash  in  Bank  and  in 
Ofl&ces 11,320.00 


$149,770.00 


Bond  Secured  by  Mort- 
gage*— 6% $26,000.00 

Interest  Accrued  on 
Bond  Secured  by  Mort- 
gage         312.00 

Accounts  Payable 21,700.00 

Reserve  for  Depreciation 
of  Building 5,300.00 

Reserve  for  Depreciation 
of  Machinery 8,000.00 

Reserve  for  Depreciation 
of  Furniture  and  Fix- 
tures       5,100.00 

Surplus 23,358.00 

Capital  Stock,  Author- 
ized, Issued  and  Out- 
standing    60,000.00 

$149,770.00 


'Building  and  realty  fixtures  pledged  thereunder. 

The  stockholders'  meeting  was  held  on  July  i,  191 1, 
and  the  dissolution  took  place.  The  company  sold  the  build- 
ing and  its  equipment  to  the  mortgagee  for  $34,000  as  of 
August  15,  191 1.  On  September  i,  191 1,  the  cash  book 
showed : 


Debits : 
Building    and    realty    fixtures,    $7,454;    machinery, 
$25,340;  shop  and  hand  tools,  $2,100;  furniture  and 
fixtures,  $3,700;  raw  materials,  $7,950;  accounts  re- 
ceivable, $23,130. 


PRACTICAL    PROBLEMS  c6o 

Credits : 
Accounts  payable,  $21,700;  expenses,  $1,530.20. 
Prepare : 

1.  The  journal  entries  affecting  the  dissolution  of  the 

company. 

2.  A  statement  of  realization  and  liquidation  that  will 

show  the  per  cent  received  by  the  stockholders 
on  their  holdings. 


PROBLEM  XXVIII 

Based  upon  the  same  principles  as  the  preceding  prob- 
lem. From  the  New  York  C.  P.  A.  Examination  of  Jantt^ 
ary,  1913.    (See  Chapter  XL.) 

James  Stetson  is  appointed  trustee  of  the  manufactur- 
ing business  of  John  Brightlawn,  for  the  purpose  of 
rehabilitation.  On  taking  charge  he  finds  that  the  avail- 
able assets  are :  cash  in  bank,  $356 ;  accounts  receivable : 
(a)  good,  $3,712;  (b)  probably  uncollectable,  $350.  The 
working  and  trading  assets  consist  of  raw  materials, 
$17,258;  sundry  manufacturing  supplies,  $700;  finished 
goods,  $8,000;  goods  in  process,  $30,945.70.  Other  assets 
comprise:  machinery  and  machine  tools,  $41,000;  shop  and 
hand  tools,  $1,300;  deferred  debits  to  manufacturing, 
$530.  The  liabilities  are  as  follows:  creditors'  accounts, 
$39,700;  wages  accrued:  productive,  $500;  unskilled,  $230. 

The  transactions  under  the  trusteeship  are  as  follows: 
Loaned  by  creditors  for  immediate  needs,  $7,000.  Pur- 
chased on  book  accounts:  raw  materials,  $8,300;  sundry 
manufacturing  supplies,  $9,500.  Factory  expense:  paid  in 
cash,  $1,300;  incurred  as  a  liability  to  creditors  and  sub- 
sequently liquidated,  $2,100.  The  doubtful  accounts  re- 
ceivable proved  worthless.    Cash  paid  for :  productive  labor. 


570  PRACTICAL    PROBLEMS 

$16,000;  unskilled  labor,  $2,500;  general  expense,  $8,000; 
additional  shop  tools,  $609;  freight  inward,  on  raw  ma- 
terials manufactured  and  sold,  $60.  Interest  allowed  to 
creditors  on  their  accounts  amounted  to  $143.10.  The 
trustee  advanced  $4,300  to  John  Brightlawn  on  account  of 
expected  profits;  the  sales  of  finished  goods  amounted  to 
$91,000. 

At  the  close  of  the  trusteeship,  the  trustee's  books  show 
the  working  and  trading  assets  to  be :  finished  goods, 
$11,000;  goods  in  process,  $10,450;  raw  materials, 
$1,945.70;  manufacturing  supplies,  $395.25.  There  is  be- 
sides an  amount  of  $750.10  representing  factory  expenses 
unapplied.  The  creditors'  accounts  show  a  balance  of 
$1,650.30,  while  the  uncollected  accounts  receivable 
amount  to  $2,975.36.  The  shop  and  hand  tools  amount  to 
$1,609. 

Prepare  an  account  which,  while  respecting  the  fidu- 
ciary character  of  the  relations  of  the  trustee  and  of  the 
proprietor  of  the  business,  will  reflect  logically  and  clearly 
the  result  of  J.  Stetson's  administration. 


PROBLEM    XXIX 

To  introduce  the  legal  requirements  of  the  bankruptcy 
schedules.    (See  Chapter  XXXIX.) 

On  July  I,  19 1 6,  John  Doe  petitions  the  Court,  asking 
to  be  adjudged  a  voluntary  bankrupt.  The  facts  embodied 
in  the  required  schedules  which  he  presents  to  the  Court 
are  as  follows: 

Statement  showing  trial  balance  of  the  books  of  John 
Doe  at  June  31,  1916,  and  the  estimated  worth  of  assets: 


PRACTICAL    PROBLEMS  c^I 

Assets 

Trial  Estimated 

Balance  Worth 

Cash  on  Hand. $1,000.00  $1,000.00 

Cash  in  Banks 5,830.40  5,830.40 

Accounts  Receivable 42,540.20  35,000.00 

Land  and  Building 60,000.00  50,000.00 

Machinery  and  Machine  Tools 31,500.00  15,000.00 

Shop  Tools 3,700.00  1,100.00 

Notes  Receivable 5,000.00  5,000.00 

Furniture  and  Fixtures 4,000.00  1,900.00 

Patents 10,000.00  3,000.00 

Stationery  and  Printing  (books  of  account  and 

records  in  use) 380.00  380.00 

Transportation  Equipment 2,350.00  1,500.00 

Materials  and  Supplies 17,000.00  9,000.00 

Goods  in  Process   (materials  only) 39,700.00  22,000.00 

Finished   Goods 21,500.00  20,000.00 

Wages 11,150.40 

Selling   Expense 3,100.00 

Factory  Overhead 2,150.00 

General  Administration  Elxpense 7,930.00 

$268,831.00    $170,710.40 
Liabilities 

Trial 
Balance 

Capital  and  Profits $60,500.00 

Mortgage  Payable,  December,  1916 40,000.00 

Accounts   Payable i37,975-6o 

Wages  Payable 3,150.40 

State  Taxes  Due 205.00 

Notes  Payable 19,000.00 

Reserve    for    Depreciation    of    Machinery    and 

Tools   5.000.00 

Reserve  for  Depreciation  of  Building 3,000.00 

$268,831.00 


Inventory  of  the  personal  property  and  debts  of  John 
Doe  at  June  31,  1916: 


572 


PRACTICAL    PROBLEMS 


Stock — 25  shares  of  Mex- 
ican Mines  —  market 

value $1,000.00 

(Par  value,  $50.) 
Household  Furniture: 
Kitchen    Utensils,    esti- 
mated worth 150.00 

Other    Furniture,    esti- 
mated worth 1,500.00 

Library,  estimated  worth.      400.00 
Wearing  Apparel — includ- 
ing S.  N.  G.  uniforms 

and  equipment 580.00 

Jewelry,  estimated  worth.      250.00 

Cash  in  House 75-00 

Cash  in  Bank 1,210.00 

Saddle  Horse  and  Equip- 
ment, estimated  worth.      395.00 

$5,560.00 


Due  for  Rent — K.  Ostengo. $200.00 

Due  for  Groceries — J.  Al- 
brecht 50.00 

Due  for  Meat — P.  Sohmer.     25.00 

Due  for  Wearing  Apparel 
— S.  Trotter 75.00 

Due  to  Clubs,  for  Mem- 
bership       80.00 

Due  to  Housekeeper,  wages 
I  month 50.00 

Due  to  Valet,  wages  I 
month 50.00 

Due  to  City  Stables,  keep 
of  Saddle  Horse 65.50 


$595-50 


John  Doe  discounted  in  June,  1916,  $4,000  of  notes 
due  August,  19 16,  and  indorsed  two  notes  of  B.  Burns, 
amounting  collectively  to  $800,  due  September,  19 16. 

Required : 
Summary  of  debts  and  assets  to  be  submitted  to  the 
Court,  made  in  accordance  with  requirements  pre- 
vailing in  such  cases. 


PROBLEM   XXX 

To  introduce  the  theory  of  the  accounts  of  executors. 
(See  Chapter  XLI.) 


PRACTICAL    PROBLEMS  e^, 

M.  T.  Fordham's  will  named  A.  Abner  as  his  executor. 
Fordham  died  May  i,  191 6;  his  will  was  duly  probated,  and 
on  May  10,  19 16,  the  Court  issued  to  A.  Abner  letters 
testamentary.  Prior  to  the  receipt  of  said  letters,  Abner 
paid  $475  for  the  funeral  expenses  of  the  deceased. 

Soon  after  qualifying  as  executor,  Abner  filed  with  the 
Surrogate  of  the  County  of  New  York  the  following  in- 
ventory of  the  assets,  established  as  of  May  10,  1916: 

1st  Mortgage,  6%,  due  July  10,  1916,  on  Land  and  Building  of 

S.  Turner,  which  is  located  at  181  st  St.,  Bronx $5,000.00 

Interest  accrued  thereon 250.00 

Note    Receivable,    J.    Simpson,    dated    March   26,    1916,    due 

May  25,  1916,  bearing  interest,  indorsed  by  J.  Spruce 1,100.00 

Cash  in  U.  S.  Mortgage  &  Trust  Company 500.00 

Cash  in  Dime  Savings  Bank 110.20 

Insurance  Policy,  New  York  Life  Insurance  Company  (pay- 
able to  estate) 1,000.00 

Salary  due  M.  T.  Fordham  by  Browner  &  Simplex 350.00 

50  shares  of  capital  stock  of  the  Bacillac  Company,  par  $100 

(worth  par) 5,000.00 

Personal  Wearing  Apparel  and  Jewelry  (appraised) 300.00 

Total $13,610.20 

The  debts  amounted  to : 

Due  for  Rent  of  Apartment $80.00 

Due  to  T.  B.  Roe,  M.D 210.00 

Due  to  Universal  Pharmacy 31-50 

Due  to  Miss  Spence,  trained  nurse 150.00 

Total $47150 


The  expenses  incident  to  the  death  and  burial  of  the 
testator  were: 

Funeral  Expenses $475-00 

Legal  Expenses  in  connection  with  Probate,  etc 150.00 

Total $625.00 


574  PRACTICAL    PROBLEMS 

The  will  provides  as  follows : 

Legacy  to  Miss  Anna  Fordham,  sister  of  testator $3,000.00 

Legacy  to  Mrs.  Mary  Fordham,  mother  of  testator 6,000.00 

Remainder  of  the  estate  to  go  to  George  and  Ruth  Tesley,  the 
testator's  nephew  and  niece. 

The  expenses  of  the  executor  amounted  to  $60.40.  Dur- 
ing the  month  of  June,  the  Bacillac  Company  declared  and 
paid  a  dividend  of  6%  per  share.  The  executor  collected 
$32.40  interest  on  bank  balances,  and  sold  the  stock  of  the 
Bacillac  Company  at  $102,  paying  no  commission  on  the 
sale,  which  was  to  a  private  party,  and  incurring  no  ex- 
penses thereunder.  The  mortgage  was  paid  at  maturity, 
with  interest. 

Having  collected  and  paid  all  assets  and  debts,  as  per 
above,  the  executor  distributed  the  legacies  in  accordance 
with  the  will,  and  rendered  his  accounting  to  the  Surrogate's 
Court. 

Required : 

1.  The  schedules  required  in  the  final  accounting  to  the 

Surrogate's  Court. 

2.  The  summary  statement  required  in  such  cases. 


PROBLEM   XXXI 

Based  on  the  theory  of  the  account  of  executors.  From 
the  New  York  C.  P.  A.  Examination  of  January,  ipo^. 
(See  Chapter  XLI.) 

By  the  will  of  Henry  Palmer,  deceased,  specific  bequests 
were  made  to  three  of  his  children,  viz. :  William,  $100,000; 
Mary,  $75,000;  and  Emma,  $75,000.     A  sum  of  $20,000 


PRACTICAL    PROBLEMS 


575 


was  bequeathed  to  charitable  institutions,  and  his  eldest  son, 
Henry,  was  named  as  residuary  legatee.  In  accordance  with 
the  terms  of  the  will  all  real  estate  was  sold,  the  amount 
realized  being  $75,000.  The  inventory  filed  by  John  Jacobs, 
executor,  was  as  follows:  bonds  and  stocks,  $87,500;  bonds 
secured  by  mortgages,  $135,000;  furniture  and  other  house- 
hold effects,  $2,750;  cash  in  bank,  $1,237.50. 

On  an  accounting  the  executor's  books  showed  dis- 
bursements as  follows :  undertaker's  bill  and  other  funeral 
expenses,  $675 ;  probate  of  will,  legal  expenses,  publishing 
citations,  etc.,  $14,278.75;  debts  of  testator,  $10,875.25; 
stationery,  postage,  etc.,  $118.75;  improvements  on  real 
estate,  $750.50;  repairs  on  real  estate,  $4,860.75;  taxes  and 
insurance,  $17,505 ;  care  of  cemetery  plot,  $350;  services  of 
accountant,  $1,800;  cost  of  executor's  bond,  $1,400. 

Receipts  were  as  follows:  sale  of  bonds  and  stocks, 
$86,327;  bonds  and  mortgages  paid,  $98,915 ;  sale  of  furni- 
ture, etc.,  $2,285.75  'y  interest  on  bonds  and  mortgages, 
$61,270.50;  interest  on  deposits  with  trust  companies, 
$1,275.45;  rents,  $17,250;  dividends  on  bonds  and  stocks, 
$37,918.50. 

The  inventory  at  the  date  of  accounting  showed  bonds 
and  stocks,  $18,755;  bonds  and  mortgages,  $30,375;  and 
cash  in  accordance  with  the  foregoing  transactions,  in- 
cluding satisfaction  of  the  specific  bequests  of  the  will. 

Prepare,  with  due  distinction  as  to  principal  and  in- 
come, a  summary  statement  of  the  executor's  accoimt,  show- 
ing the  amount  of  the  executor's  commission  and  the 
amount  due  the  residuary  legatee. 


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